Divorce means the unwinding of a life built together, and one of the aspects of this process can be the division of retirement accounts. These accounts represent years of saving for a future that may no longer be shared, and their division requires careful consideration to avoid unintended tax consequences and to help secure each spouse’s financial future.
Although retirement accounts are individually owned, they may be treated wholly or partly as marital property when a couple gets divorced. A divorce court will divide these accounts and their vested benefits according to the rule of equitable distribution. That means dividing them fairly, but not always equally.
Several types of retirement accounts can be subject to this treatment during a divorce. Here’s a breakdown:
- 401(k)s and similar employer-sponsored plans — These are among the most common retirement accounts. They allow employees to contribute pre-tax dollars, thereby reducing their taxable income. During a divorce, the marital portion of the account, typically contributions and growth accrued during the marriage, needs to be divided.
- IRAs (traditional and Roth) — Individual retirement accounts offer tax advantages similar to 401(k)s. Traditional IRAs hold pre-tax contributions, while Roth IRAs hold after-tax contributions that grow tax-free. Division of an IRA follows similar principles as that of a 401(k), with the marital portion being split.
- Pensions — Defined benefit plans, commonly referred to as pensions, provide retirees with a fixed monthly income based on such factors as salary and years of service. Dividing pensions can be more complex, as they involve dividing future benefits that may not be entirely determined. An actuary might be needed to determine the present value of the benefit, which can then be split between spouses.
A major concern with dividing retirement accounts is the potential for adverse tax consequences. Early withdrawal from these accounts typically triggers income tax and penalties. To avoid this, a legal document called a Qualified Domestic Relations Order (QDRO) is essential. A QDRO is a court order that instructs the retirement plan administrator to directly transfer a portion of the benefits to the non-employee spouse. This allows for a tax-free transfer, preserving the retirement savings’ tax advantages.
Given the complexities involved, it’s highly advisable to seek a Michigan divorce attorney experienced in retirement account division. Your attorney can help you understand the value of your accounts, determine the marital portion and negotiate a fair division with your spouse. Your attorney can also guide you through obtaining a QDRO to ensure a smooth and tax-effective transfer.
At Dawson Family Law, PLLC, we help Michigan clients to consider whether the splitting of retirement assets will be an aspect of their divorce and, if so, how best to proceed. Call my Sterling Heights office at 833-671-4445 or contact me online.
