It can take decades for people to set aside enough money to live comfortably during retirement. Some people are eligible for pensions provided by their employers. Others have to make direct contributions to a retirement savings account.
401(k)s are a popular account type because they offer tax benefits for professionals. People can diminish their taxable income for the year by making contributions to a 401(k). In some cases, their employers may even make matching contributions.
Those savings might be vulnerable when married professionals divorce. How do spouses with 401(k)s protect their savings when they divorce?
With direct negotiations
One spouse might believe that a retirement account is their separate property. If they are the only one who made contributions to the account or if they started the account before getting married, they may assume that they do not have to share what is in the account when they divorce.
However, retirement savings are often subject to division. The courts look at whether people used marital income for deposits rather than the name on the account when deciding whether it is subject to division in a divorce.
A 401(k) may be at risk of division in litigated property division proceedings. Splitting the account may be the easiest way to achieve a fair and reasonable split of assets. A spouse who aims to retain the entirety of their retirement account may need to work at settling with a spouse.
Negotiations that lead to an uncontested divorce can give someone control over property division terms. So long as they agree to let their spouse keep other valuable assets, they may be able to retain their entire account instead of dividing it.
With the right paperwork
Attempting to divide a 401(k) can cause secondary losses in addition to the amount claimed by the other spouse. Specifically, people may have to pay a penalty if they are not yet at retirement age. That penalty can cost an additional 10% of the amount withdrawn prematurely.
The amount withdrawn can also increase their taxable income for the year, leading to a higher amount due in income taxes and the risk of an underpayment penalty when they file their annual income tax return. The use of a qualified domestic relations order (QDRO) can help eliminate those particular concerns.
People who file appropriate paperwork with the professional or business managing the 401(k) can eliminate tax consequences and financial penalties usually assessed after a pre-retirement withdrawal from a 401(k). They have to draft the QDRO after the courts approve a property division order.
Spouses who establish clear financial priorities at the beginning of the divorce process can focus on securing terms that set them up for long-term financial stability. Protecting a 401(k) is a common and reasonable goal to set during a divorce.
