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Protecting your retirement account in divorce

On Behalf of | Apr 2, 2024 | Divorce

One of the reasons the decision to divorce is so difficult for many California couples is the potential disruption to their financial lives. Perhaps you are in this situation. You might know that emotionally your marriage is over, and that divorce is the best step for everyone, but be worried about losing the financial stability that often comes with marriage.

This is an understandable concern, especially for older couples who have built up significant assets such as retirement accounts.

Aside from a home, retirement accounts are one of the biggest assets a married couple has. You may not want to risk losing some of your retirement account to your spouse.

Although this usually is not a reason to stay married, it is important to know how California law treats retirement funds.

Which portions are marital or separate property

California law states that any income earned during the marriage is marital property. Common retirement plans, such as a 401(k) or an IRA are typically considered marital property because the contributions are made with marital funds.

For the same reasons, pensions are also usually considered marital property. The only portions of a retirement account labeled separate property are generally any contributions made to the account before you were married, and any interest earned on those contributions.

One of the first steps in the property division process is to create a list of all marital assets and their values. When you have this list, you can examine exactly what retirement accounts are marital property and determine how their values impact the overall property division.

Equitable distribution and your retirement account

Under the law, marital property must be divided equitably or fairly. While this could mean you must part with a portion of your retirement fund, there may be other ways to achieve the same result while keeping your retirement account intact.

If you and your spouse both have retirement accounts that have approximately the same values, you can decide that you both keep your own accounts. Any other marital property should be divided equitably to achieve the overall goal of equitable distribution.

This is not always possible, especially if you have a retirement account and your spouse does not or if your retirement account has a significantly higher balance than your spouse’s.

In this situation, you can choose to give your spouse a greater share of another marital asset, such as a bank account. However, you will likely need to examine the tax implications of this type of arrangement.

Qualified domestic relations orders

Your spouse might get taxed on any income or assets they receive as part of the divorce. When a retirement account is divided, a qualified domestic relations order (QDRO) avoids any tax penalties.

QDROs are only used for certain types of retirement accounts. Retirement accounts covered by the Employee Retirement Income Security Act (ERISA) qualify for a QDRO.

A QDRO allows plan administrators from your account to distribute funds to your spouse. Your spouse must withdraw the funds and place them into a different retirement account to avoid the tax penalty for an early withdrawal.

The division of retirement plans during divorce is often complex. If you have never gone through the process before, a simple mistake could result in financial complications for many years to come. Therefore, knowing the law and specific requirements for your retirement plan is important.