Understanding retirement accounts and how we deal with them in divorce - Collaborative Family Law Association of St. Louis

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Understanding retirement accounts and how we deal with them in divorce

John Ernst

In a typical divorce, the biggest assets are the family home and the couples’ retirement accounts. Here are a few things to understand about retirement accounts and what a couple’s options are for dealing with them in their divorce.

There are two main types of retirement accounts: 401(k)s and Individual Retirement Accounts (IRAs). While both kinds of accounts are used to save for retirement, there are some important differences.

401(k) plans are sponsored by employers whose employees can contribute pre-tax dollars to their 401(k) through paycheck deductions. The 401(k) distributions are taxed at the participant’s ordinary federal and state income tax rates. There is a 10% early withdrawal penalty if the distributions are taken out before age 59 ½. A participant can also contribute after-tax dollars through paycheck deductions into a Roth 401(k). Since these are after-tax contributions, Roth 401(k) distributions after the age of 59 ½ are not taxable. Many employers will match a portion of their employees’ 401(k) contributions.

401(k)s are divided in a marital dissolution case through a Qualified Domestic Relations Order (QDRO, pronounced “Quadro”). A QDRO directs the plan administrator to pay the non-employee spouse their portion of the 401(k). Generally, the non-employee spouse elects to have their portion of the 401(k) directly transferred to an IRA in their name. No taxes or penalties are due as a result of this transfer.

IRAs function very much like 401(k)s, but they are created by the individual directly rather than by the employer. Contributions to IRAs can only be made if the person has earned income. The two main types of IRAs are traditional and Roth IRAs. Contributions to traditional IRAs may be deductible on the individual’s income tax returns, subject to some income limitations. Contributions to Roth IRAs are not deductible on the individual’s income tax returns. Just as with 401(k)s, funds distributed from traditional IRAs are taxed at the individual’s ordinary federal and state income tax rates. Roth IRA distributions are not taxed because the contributions are not deductible on the individual tax returns. The 10% penalty on pre-age 59 ½ distributions applies to IRAs. That penalty doesn’t apply to Roth IRA distributions, except with regard to distributions of income earned on the account.

Just as with 401(k)s, IRAs can be divided as part of a divorce. They don’t, however, require a QDRO. Instead, the plan administrator will need a certified copy of the dissolution judgment. The transfer from the IRA owner to the non-owner spouse will generally be made into the recipient’s IRA, just as with a 401(k).

Understanding these concepts can help you achieve a more equitable result in your divorce.

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