Retirement accounts such as pensions, 401(k) accounts and IRAs can represent a significant portion of a married couple’s wealth. If such a marriage ends in divorce, the spouses will likely need to divide all or part of a retirement account as part of the property division process.
Dividing a retirement account in divorce is a complicated and risky matter. If the parties aren’t careful, they may destroy much of the value of an account they both need to help them through their later years.
Is your retirement account community property?
Texas follows the community property law model in divorce. This means that all assets acquired during the marriage are jointly owned by the spouses. If they decide to divorce, they can — theoretically, at least — divide their community property equally between them. (In practice, the division typically involves a fair amount of negotiation and likely does not end up as a 50/50 split.)
So, the first step in dividing your retirement account is figuring out whether the account is community property, and if so, how much of it is subject to property division.
If you started contributing to the account during the marriage, the entire account may be considered community property. If you started contributing before the marriage, the contributions you made before the marriage will remain your separate property. For instance, if you contributed $10 a month through your job for five years before you got married, for a total of $600, that $600 is your separate property. However, if that $600 gained interest during the marriage and is now worth $1,000, the $400 in interest may be subject to property division.
Taxes and penalties
A key feature of many types of retirement accounts is that they are not subject to taxes, so long as the owner doesn’t withdraw from the account until they retire or reach a certain age. If they do take money out of the account before they reach this kind of milestone, they must pay taxes on the interest accrued in the account. They may also face a penalty from the financial institution that holds the account.
These taxes and penalties can be significant, and so a person who withdraws a retirement account prematurely in divorce can greatly reduce the value of the nest egg they will need to see them through their retirement years. On top of that, they will have to divide the account with their ex.
QDRO
The best way to handle your situation depends on the exact type of account involved, but one typical solution is through a Qualified Domestic Relations Order. A QDRO is a court order that instructs the financial institution to divide the account between two people. For instance, if you had a retirement account through your employer and, according to the terms of your divorce, you must give your spouse 30% of its value, the financial institution may withdraw that amount in the form of a check that goes to your ex. Your ex must then deposit it directly into a new retirement account.
The process must be handled carefully. Experienced professionals can help you through the process.