How Are Retirement Accounts Handled in Divorce?

There are many challenging aspects of divorce but one that can be difficult to comprehend and prepare for is the various financial implications of divorce. Dividing assets is complicated and emotional, but it must be done. Beyond things like physical assets and bank accounts, there are trickier things like retirement accounts that must be addressed. Because retirement accounts are often one of the most valuable assets in a marriage, it is essential to understand how they are handled in a divorce.

In a divorce, retirement accounts, just like other marital assets, are subject to division between the parties, even if they are only in one spouse’s name. However, the division of retirement accounts can be more complicated than other assets due to the different types of accounts and the tax implications of dividing them.

There are two primary types of retirement accounts: defined contribution plans and defined benefit plans. Defined contribution plans, such as 401(k)s, allow employees to contribute pre-tax income to an investment account, which grows tax-free until retirement. Defined benefit plans, like traditional pensions, guarantee a specific benefit to the employee upon retirement, based on factors such as years of service and salary.

Generally, if you live in a community property state, retirement accounts are divided equally, just as other marital assets are. When dividing retirement accounts, one option is to split the account in half, with each spouse receiving an equal share. Another option is for one spouse to keep the retirement account, while the other spouse receives other assets or a cash payout to compensate for their share of the account.

It is important to work with a mediator as well as tax and financial specialists to ensure retirement accounts are divided fairly and to minimize tax implications. For example, if a spouse receives a cash payout from a retirement account, that money may be subject to income tax and possibly an early withdrawal penalty. On the other hand, if the account is divided through a qualified domestic relations order (QDRO), there may be no tax consequences.

Working with a divorce mediator who has experience handling retirement accounts can help couples navigate these complex issues. A mediator can help couples understand their options and make informed decisions about dividing retirement accounts that are fair and equitable.