There are many different kinds of retirement benefits that spouses may have. According to the IRS, each plan has a slightly different description. The most typical plans are defined as the benefit or pension plans, profit-sharing plans, IRA's, 401k, and defined contribution plans. Most mid-sized to larger sized employers offer 2 different types of plans to their employee's either a defined benefit plan or a defined contribution plan.
The first step in dividing, equalizing, or offsetting any cash out of a retirement account is to determine whether any or all of the retirement funds are marital or community property. Some may be partial marital property or community property. It's all dependent upon which contributions were made during the course of the marriage.
Once this is determined, then there are 2 options for the 2 Party's to consider. Either divide the retirement benefits and determine the value, or offset it with other marital assets to make it even in distribution.
Divide The Retirement
When getting a divorce, the only way to pay money from one spouse's account to another is with a QDRO. In short, it's not acceptable to simply state that one party or the other is awarded the account. It's not that simple and it won't be accepted by a court. You'll have to go through the proper channels to ensure that the division is fair and equitable.
QDRO pronounced Quad-ro), is an order by the court that is utilized to divide the retirement plan. This actual order may be via a Qualified Domestic Relations order for either a private plan or for a Domestic Relations order via a public plan.
We work closely with QDRO counsel which is a legal technology company that helps in dividing pension funds. fonded by a team of nationally recognized Valuation and QDRO experts, they use their service to offer support as well as guidance and coaching from QDRO attorney's. You can also consult other resources.
Equalize And Offset Retirement Account
Is it possible to offset the balance against defined benefit plans or other defined assets? The parties may decide that they wish to equalize and offset their defined benefit cash plan or traditionally defined plan for benefits against other assets that they may have. This is definitely possible, however, it's not typically recommended unless the marriage was quite short. The longer the marriage, the more assets each party will likely have and the more complicated the situation may become.
Why is this? Because defined benefit plans often function differently than those that are defined such as a 401K or an IRA account. Defined contribution plans or IRA's have a known account balance on specific dates, in a defined benefit plan, there's no value until the person begins the benefit. Since there isn't any value until the person retires, the value should be actuarially calculated upon the current date with the estimated value. Thus, when the defined benefit plan is equalized and then offset against other assets, there's no way to know if the estimate is over or understated. It may or may not be fair to both parties.
What is the determination for the equalization and the offset?
To begin, it must first be determined what the value of any retirement plan benefits and other property that is being factored into the offset and equalization is. If there's separate interest in the property, this will also have to be factored into the separate property as well as the community and marital property.
Different benefits affecting the offset are likely invested differently when considering the actual date of equalization and the offset must be calculated accordingly. Should the investment choices vary in any substantive way, then one of the spouses may end up with more than the other at the time of the actual distribution. Should the investment choices be similar, then it won't make such a large difference in the actual distribution. Both parties would then be given the same portion accordingly. With an equalization, the offset won't result in ideal distribution. Each plan must be divided separately to ensure that everything is equal. Regardless, it may be wise to consider "horse-trading" based upon the estimates depending upon the situation at hand.
How Does Equalization And Offset Calculation Work?
Typically it will work best in the shown example for both Parties:
1. Factor in the division date such as 12/31/2016. The division date is the applicable marital division date that is based upon the specific state of residence's law as per any court-ordered or party agreements.
2. Factor in the total marital and or community interest for the benefits as per the date of division as per below:
ABC 401K $100,000
def 401k $200,000
XYZ $ 50,000
Total Marital And Community Interest: $350,000
Each party's interest: $175,000
Thus, party 2 is going to be awarded 100 percent of their XYZ plan benefits in the amount of the $50,000.
Party 2 will also be awarded their remaining interest of $125,00 from Party 1's DEF 401K plan as of the actual date of division as well as any investment earnings or losses.
Party 1 will be awarded 100 percent of their own ABC 401K plan of the $100,000 as well as the remaining balance of the DEF 401K plan after the payment is made to Party 2 via the QDRO.
Does dividing the defined contribution result in any tax advantages? This is a complicated question that must then be analyzed closely before coming to the actual answer. Using a QDRO for the contribution plan, the alternate spouse may move the funds to another IRA or another qualified plan, or they may take the funds out as cash. However, if they receive the funds as cash and don't roll them over into another qualified plan or an IRA, they must pay taxes on the funds as per the requirements for early withdrawal if the person is younger than 59.5. This is listed in the IRS Code Section 72(t)(2)(c).
Thus, if the parties wish to receive cash directly from the other party's plan, and they're willing to pay the taxes, then doing a QDRO is the better route to go for the qualified contribution plan.
Should the participant wish to cash out a retirement plan is it possible? While it's certainly possible, it's not typically advisable as, in rare situations, the spouse withdrawing the money may be the one that has to pay the income tax on the withdrawn funds. It's always wiser to get the QDRO done for each Party's retirement plan will represent a fair division of the assets.
Clearly, there's not a one-size-fits-all method of dividing the assets. It's vital to seek out a trusted QDRO expert to answer any questions that may arise on the subject. If you're unsure of which route to go, they can properly advise you on your options and what would represent a fair division of the assets.