Common Questions About Retirement Accounts in Divorce

1. Can a retirement account be divided without triggering taxes?

A tax-free division is possible, but each plan or account has different requirements. Before signing any agreements in divorce, consult with each plan administrator (or account custodian) to properly analyze the process needed for a tax-free division. Without the correct process, clients may be subject to significant taxes, penalties, and ultimately, an inequitable division. Qualified plans such as a 401k require a QDRO to divide the account. IRA’s and Roth IRA’s require a divorce decree and the custodian specific forms to divide the account tax-free.

2. Is a retirement plan more or less valuable than other assets?

Retirement assets are only part of a family’s total financial picture. Moreover, liquidity is key to starting a financial life over again. A CDFA professional should rate each asset for liquidity and tax consequences to help match the division to the client’s financial goals and priorities. Most retirement plans rank lower than other assets because withdrawals are taxed at the owner’s tax rate plus a possible 10% penalty.

3. Is a retirement account separate property?

Generally speaking, in Texas, retirement benefits earned by either spouse during the marriage are community property and can be divided. A CDFA professional can assist attorneys by gathering relevant documents and by being familiar with calculating the coverture fraction for pensions and tracing for a 401k.

4. Should you “tax affect” retirement accounts when dividing assets in divorce?

Many divorce professionals will “tax affect” retirement plans (discounting the account by the recipient’s highest marginal tax rate). In order to properly “tax affect” each plan or account based on economics, the parties would need to know when and how much will be withdrawn, tax rates for each party, and the rate needed to discount the tax expense back to today’s dollars. By preparing financial projections, a CDFA professional can assess the amount and timing of the recipient’s anticipated withdrawals from retirement accounts. By discounting the future tax expense, the analyst can assess whether and how much to “tax affect” or discount the value.