When you're in the process of divorcing or realize that divorce is imminent, you may have a lot of questions and concerns. Couples may focus on the different steps of the divorce process, the division of equity in the marital home or who will get primary custody of the minor children. However, it's equally important to understand that divorce can and will have an impact on your retirement accounts.
You may think that because your retirement account is only in your name that you won't have to share its content with your spouse during the divorce. Unless you have a prenuptial agreement in place that explicitly states you will retain the entire proceeds from your retirement account, you most likely will end up splitting these retirement funds with your spouse.
Divvying up the pensions can mean that you have far less saved than you had hoped to by this point in your life. Understanding this process can help empower you to make better financial decisions moving forward.
Dates of deposits, not the name on the account, matter most
Connecticut is an equitable distribution state, which means that the courts will seek to fairly divide all assets acquired during the marriage. Fair and equal are not always the same, however.
For the purpose of your retirement accounts, “fair and equal distribution” means that if deposits were made into the account during your marriage, the courts will likely consider those funds subject to division. The amount deposited in your Roth IRA or 401K during your marriage will typically end up impacting the total asset division process.
Sometimes, the courts may award the retirement account to one party and simply deduct that amount from the value of the other assets split in the divorce. Other times, the courts may order that the retirement accounts must get split between both spouses. That court order protects you from any fees or fines associated with an early withdrawal of retirement funds.
You need special paperwork to avoid fines, tax penalties and fees
You are likely familiar with the early withdrawal penalties for your retirement account. The good news is that when retirement accounts get split as a result of a court order, you won't have to worry about those costs. You will need to follow specific procedures and file specific paperwork to avoid incurring any penalties.
For those with a 401K, a Qualified Domestic Relations Order (QDRO) is used to divide retirement accounts without penalty. Generally, the courts will refer to any documents ordering the division of retirement accounts as QDROs, even if they technically have other names for different retirement products. Each QDRO requires specific information, including the name and mailing address of the recipient of the split funds, as well as the percentage that person will receive and the frequency or number of disbursements.
The good news is that, in addition to avoiding penalties and extra taxes, once you submit a QDRO to your retirement fund administrator, your work is done. The plan manager will handle transferring the assets to the new account, which is typically an IRA. From there, you can work on rebuilding the assets that you had to split with your spouse.