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Financial stakes high when divorce splits retirement plans

| May 10, 2021 | Divorce

Aside from real estate, retirement plans often form a very large portion of the marital estate in North Carolina. Defined contribution 401(k) plans sponsored by employers may contain hundreds of thousands of dollars. Company pensions could be worth six figures during the final decades of life. Your divorce will require a reckoning of who gets what from these retirement savings. Any missteps when dividing retirement assets could trigger big tax bills or prevent you from collecting a pension.

Taking the cash produces tax bills

In the typical 401(k) plan, your money enjoys tax-deferred status. This means that you do not have to pay income taxes on your contributions until you withdraw them years later as retirement income. The Internal Revenue Service regards any distributions from your account as a taxable event except under certain circumstances.

Plans compliant with the Employee Retirement Income Security Act, like 401(k) plans, allow for nontaxable distributions during a divorce. However, tax avoidance relies on immediately putting the money into another tax-advantaged retirement account. If you simply accept the cash, then you owe income tax on the money plus early withdrawal penalties. To complete a nontaxable distribution, you need to complete a qualified domestic relations order that directs the money into a new retirement account.

Pension survivorship options

For people with pensions, a divorce requires thinking about the value of the pension down the road. Unlike a defined contribution plan or IRA, a pension specifies the amount of money people receive when they retire. When negotiating a divorce that involves a pension plan, a person should evaluate the pros and cons of survivorship options. The ex-spouse of the person who earned the pension may have the option to retain benefits upon that person’s death as survivorship benefits. The income during retirement even after the ex-spouse’s passing could prove valuable.

Family law directs people to reach an equitable agreement about how to divide assets and debts during a divorce. The value of retirement assets and their tax obligations could have a large effect on the final settlement.