Divorce and retirement assets can be very challenging. When determining an equitable division of retirement assets in a divorce context, it is generally best to start by looking at where the couple is in the life cycle. In other words, how close are they to retirement? Some may already be in payout status, while others may be much younger and only beginning to contribute to a 401(k). This factor will make a significant difference in deciding how to equitably divide any assets.
Retirement assets are typically set up in either one spouse’s name or the other. That does not mean that the spouse retains sole ownership rights, however. In most cases, such assets are still considered to be marital property, particularly if funds accrued primarily during marriage.
If the couple has only been married for a short amount of time, this can be different. In this case, the most equitable decision may be to divide retirement assets based on both the amount each party brought into the marriage and the degree to which contributions were made during the marriage. (Keep in mind that “equitable” does not always mean “equal” in a 50/50 sense.)
One reason for the marital property rule is because while they were still together, the couple likely made joint decisions about how to save for retirement. For example, they may have decided that one party would stay home to raise children while the other worked and built up a 401(k) account. Or they may have decided to focus on building up one of their retirement accounts more than the other, because one of them made more money or had a higher employer match. They may even have chosen to cash out one spouse’s 401(k) and paid the penalties because they needed to live on the funds for a while, or one party may have been out of the job market for a season due to poor health, a struggling economy, or some other reason. All such decisions may have made sense while the couple was still together, but once they decide to divorce, it becomes important to prevent one party from being penalized if his or her retirement account is affected due to prior joint decisions.
Factoring in an Age Gap
Couples who have a larger age gap between them have unique considerations. One may already be collecting from a pension or Social Security, while the other may be quite a bit younger and still in his or her prime earning years. The younger spouse may feel that any equitable division of retirement assets should factor in the reality that s/he will be saddled with various expenses for a much longer time than the older spouse, while the older spouse may argue that s/he has far less time to build up funds again. One spouse may even be on disability by this point, which can affect decisions and cash flow.
It is important to consult with a Mediator or Collaborative Practitioner (CP) to resolve some of these differences in perspective and come up with a fair solution.
Pensions and Social Security
Though pensions are not as common today as they once were (having been replaced by 401(k)s in many cases), a divorcing couple may still have either a civil service (federal, state, or town) or military pension, or an older pension plan—perhaps even from a prior employer (that you may even have forgotten you have!). Although many pensions are governed by federal laws, each pension type has different rules (some of which vary by state), so it is important to find out what rules apply to your particular pension.
According to Massachusetts state law, in cases of divorce a state pension can be valued or divided in some way, but under Federal law, Social Security benefits cannot. 401(k) plans are easily valued and can be divided. These different treatments can create inequities if not addressed. An actuary can determine the value of Social Security benefits as a lump sum, which can, for instance, be helpful in coming up with an offset to make any pension disbursements more equitable. Government pensions may not allow “double dipping” with a simultaneous Social Security collection, unless the individual worked another 20 years in a non-government job.
The rules are varied and complicated. Having professional assistance can make a huge difference in what is able to be collected or allocated. Any transfer of retirement assets must be done through the proper process, usually through the creation of a Qualified Domestic Relations Order (QDRO). Again, professional assistance is critical to be sure this is done correctly.
If a couple has been married for at least 10 years, the spouse with fewer or no Social Security benefits is entitled to half of the higher-earning spouse’s Social Security benefits at retirement age. (The higher-earning spouse will still receive 100% of his or her benefits.) It becomes important to determine whether it is more beneficial for this spouse to choose to receive 100% of his or her own Social Security benefits, or 50% in spousal benefits.
Be aware that in the case of military pensions, typically the rights of the individual who served are protected more than those of the divorcing spouse.
Individual Retirement Accounts
Individual Retirement Accounts (IRA) are another type of retirement asset and include traditional and Roth accounts, both of which have different tax treatments. The transfer or allocation of these accounts is also technical and must be done carefully to avoid or minimize tax consequences and to maximize the amounts that the parties retain.
Effects of Divorce on Long-Term Planning
Married spouses often spend years devising a strategic way to save for retirement, but divorce has a way of changing even the best-laid plans. For example, a couple may have anticipated receiving a significant inheritance down the road, but if they divorce while the rich relative is still alive, that perceived inheritance cannot be factored in as part of the divorce settlement. It is important not to make any assumptions about how retirement will pan out, even while still married.
That being said, there are usually more options available than most divorcing couples realize. It is important to consult with an expert, both to find out what is at stake and to come up with creative ways to stretch and divide any joint retirement assets.