If you are getting divorced, is your spouse’s 401(k) an asset you should share when the marriage is dissolved?
Retirement plans such as 401(k)s are company plans offered to employees. The 401(k) is not an asset you jointly own with your spouse. In fact, it’s a benefit offered to your spouse by your spouse’s employer. If you don’t work for your spouse’s employer, can the retirement account be split? What if the 401(k) was started before the marriage?
The answer to all of these questions is yes, but only if the requirements are met related to the federal laws governing 401(k)s – ERISA (the Employee Retirement Income Security Act of 1974) and the Internal Revenue Code.
Other than an exemption we’ll talk about in a moment, federal law does not permit an employee’s 401(k) to be assigned to someone else, even a spouse. The rationale? To ensure that the employee’s retirement benefits actually go to the employee when he or she retires.
But the law permits an exception for an “alternate payee.” The proper procedures must be followed to comply with ERISA. And if they are, the local divorce (or family) court can order a distribution to the spouse.
Once the divorce or family court determines that the 401(k) will be split between the spouses, a special order must be drafted and approved by the court. The order is called a QDRO, which stands for qualified domestic relations order.
A properly drafted QDRO is the mechanism that is used to transfer assets from the owner of the 401(k) to his or her former spouse. It is the only way a former spouse can receive a nontaxable assignment of all or part of a spouse’s 401(k) plan.
Normally the portion of the employee’s 401(k) that goes to the spouse is transferred into the spouse’s individual retirement account (IRA) to avoid a taxable distribution. For example, an employee’s 401(k) balance of $1 million might result in 1/2, or $500,000, going to the spouse. The spouse’s $500,000 is transferred to his or her IRA, and the remainder stays in the 401(k). There is no income-tax consequence to either spouse.
A QDRO also may be used to assign all or part of a 401(k) to a child or other dependent to satisfy family support obligations. In the case of a minor child, the QDRO can direct that payment be made to the child’s trustee or guardian. QDROs for children tend to be rare. QDROs also are used for assigning pension assets.
This discussion is very general. For details on QDROs, I highly recommend a booklet published by the U.S. Department of Labor (DOL) called “QDROs: The Division of Retirement Benefits Through Qualified Domestic Relations Orders.” The 100-page booklet, developed by the DOL in consultation with the Department of the Treasury and the Internal Revenue Service, is useful to plan participants as well as plan administrators. You’ll find detailed question and answers, and sample documents. The booklet is online at https://tinyurl.com/y72whool, or you may call 866-444-3272.
You don’t want to agree to a property settlement without first quantifying the value of your spouse’s 401(k) account. Work with a lawyer who is familiar with ERISA issues and the valuation of qualified plans. When valuation is an issue, you can request a valuation from the plan administrator or call in a qualified actuary. And when your lawyer presents you with the divorce settlement, satisfy yourself that pension and 401(k) assets are dealt with adequately. Because divorce is a time of disruption, take your time to understand what is being presented.
Julie Jason, JD, LLM, a personal money manager (Jackson, Grant of Stamford, Conn.) and award-winning author, welcomes your questions/comments (email@example.com). To hear Julie speak, visit www.juliejason.com/events.