If you’re like many Americans who have been in the workplace for a few decades or longer, a good deal of your assets may be in retirement accounts of various types. You may have a 401(k) or an individual retirement account (IRA). You may have a pension plan – particularly if you work for a local or state agency — or a thrift savings plan (TSP) if you work for the federal government.
If you are going through a divorce, you and your spouse may need to negotiate if and how you both want to divide your retirement accounts. If you’re not able to agree, a judge will need to make the decision based on Virginia’s equitable distribution laws. One advantage of choosing a collaborative divorce, however, is that it may allow you and your spouse to work out your property division plan outside of court, with the support of your individual legal representatives.
Dividing a 401(k) plan
If you have a 401(k) plan through your employer, you’ll likely need to use a qualified domestic relations order (QDRO) to divide it. This is for “qualified” plans like 401(k)s established under the Employee Retirement Income Security Act of 1974 (ERISA).
A QDRO, which is essentially a court order signed by a judge, allows the account holder to withdraw funds to transfer to their spouse in divorce without having to pay early distribution penalties or report it as taxable income. Without a QDRO, you could end up paying a lot of your retirement savings to the government unnecessarily.
Dividing an IRA
If you have retirement savings in an IRA, any transfers made to your spouse as part of the property division agreement also need to be protected from taxes and early withdrawal penalties. That means you need to notify your IRA custodian (the financial institution or other company where you have the IRA) that the transfer of funds is “incident to the divorce.”
As noted, there are several different tools that people use to save for retirement. They all have their unique rules, requirements and penalties for withdrawals. No matter which type(s) you have, it’s important to understand how to protect your money, whether you’re transferring funds to your spouse or they’re transferring funds to you.
By seeking legal guidance, in addition to seeking financial and tax advice, you may be able to deal with the retirement account portion of the property division process without unnecessary financial consequences.