People spend years, even decades, building and contributing to their 401k accounts and other retirement funds. Careful planning for retirement is very important, and people work diligently to ensure that they have enough saved for their golden years. But what happens when you divorce? In community property states like California, a divorce can seriously derail your retirement plans, let alone your retirement accounts themselves.
Dealing with 401k and other retirement accounts during a divorce is incredibly challenging. Below we discuss how retirement accounts are divided during a divorce and provide guidance on what you can do to protect your 401k from a divorce.
How Are Retirement Accounts Divided in California?
As previously mentioned, California is a community property state. When a couple marries, the two parties form a single community. Upon a divorce, any property (or debts) acquired during the marriage must be divided equitably between both community members. In some cases, this means a 50/50 split of assets, while in others, there may be other ways that couples achieve an equitable division.
Retirement accounts, like 401k plans, are subject to property division. However, they are frequently more complicated than dividing a shared bank account or real estate. Many people come into marriages with 401k plans already established. However, because they continue making contributions during and throughout the marriage, the 401k plan is not solely classified as separate property.
What Is Separate and What Is Community Property
In cases where there is mixed community and separate property, you must figure out which contributions were made before and which were made during the marriage. Contributions made prior to the marriage are separate property, and those after are community property. After you have officially separated, contributions go back to being separate property. Note: your official date of separation is not the same as the date your final divorce decree is issued – speak with your lawyer for help figuring out your official separation date.
401k plans are also difficult to divide because these plans continue to earn interest over time on the contributions made. There are also significant tax implications and penalty fees associated with taking money out of a 401k (or another account, like an IRA) early. Because of this, many people require the help of both their lawyer and a financial expert to ensure that the division of the account is completed accurately and fairly.
Ways to Protect Your 401k During a Divorce
No one plans to get divorced, and the entire process can be emotionally and financially devastating. However, there are things you can do to help protect your retirement from a divorce. While you may not be able to prevent your former spouse from getting a share of your 401k plan as part of the property division process, you do have options to both limit how much your retirement account is impacted and to protect what is left. Keep reading to learn more.
Establish a Prenuptial or Postnuptial Agreement
One of the best ways to protect your 401k from a divorce is to establish a prenuptial agreement that designates your retirement account as separate property. However, not everyone has a retirement account when they get married, or they may not think to establish protections in a prenup. If you are already married and would like to establish your 401k as separate property after the fact, you and your spouse can work with a lawyer to develop a postnuptial agreement.
To learn more about prenuptial agreements, review our blog post here.
Qualified Domestic Relations Order (QDRO)
Generally speaking, when someone withdraws money from their 401k plan early, they are faced with a financial penalty for doing so. On average, withdrawals made before the account owner turns 59 ½ are subject to a 10% penalty. However, in some cases, a qualified domestic relations order (QDRO) can help you avoid these penalties when dividing the account during the divorce process.
A QDRO is a court order used in divorce cases to designate a portion of a person's 401k account (or other retirement plan) to be dispensed to another person. When there is a QDRO on file, the retirement plan administrator will automatically distribute the appropriate funds to the correct people. QDROs are not only helpful when it comes to avoiding penalties associated with early withdrawal from a 401k but can also help the division process go more smoothly.
Work with an Experienced Negotiator or Mediator
Many people are concerned that everything must be split down the middle when dividing property, including their 401k plans. However, this is not always the case. The goal of property division is to ensure that assets are divided equitably and fairly. However, achieving this does not always mean that every asset has to be equally divided.
Common property division solutions that do not involve splitting retirement accounts include:
- When both spouses have their own retirement accounts, they each agree to retain their personal accounts without dividing either
- One spouse retains the retirement account while the other takes possession of other assets of approximately equal value (such as real estate or other material assets)
- The spouse who retains the retirement account agrees to take on more of the marital debt
By working with an experienced negotiator or mediator, you and your former spouse can benefit from their experience and knowledge, and in many cases, find a solution that protects your retirement account while remaining fair to both parties.
Speak with a Financial Expert
If you are in a situation where you have had to divide your 401k, giving a significant portion to your former spouse, you are likely worried about how you will financially recover from this. This is a very stressful position to be in. Working with a financial advisor or another financial expert can be a significant help. They can review your finances and help you come up with a plan for rebuilding your retirement account after a divorce. For example, you may have assets to sell, freeing up money to put back into the 401k.
If you are going through a divorce or planning on filing for divorce, reach out to our law firm to schedule a consultation. Our attorneys have extensive experience helping individuals with complicated financial situations navigate the divorce process.