Protecting Retirement Accounts from Divorce

Texas is a community property state. This means that when spouses divorce, Texas will divide all of the marital property based on what is “just and right,” no matter how the marital property is titled. It generally doesn’t matter that your retirement benefits or your spouse’s retirement benefits are titled in just your name or just your spouse’s name. The family courts in San Antonio (in Bexar County) will consider pensions, 401(k)s, IRAs, and any other retirement benefits when dividing marital property.

There are different considerations that will affect which retirement assets are divided, when they are divided, and how they are valued.

Premarital agreements

One way that a spouse can protect their retirement benefits is through the use of a premarital agreement (called a prenuptial agreement). Prenuptial agreements are contracts between the spouses as to how their assets will be divided in the event of a divorce. Generally, premarital agreements can resolve how property is divided and the amount of spousal maintenance (alimony). Premarital agreements cannot resolve custody and child support because the court must determine what is in the best interest of the children.

If you or your spouse has retirement interests prior to your marriage, then a prenup can provide that if the spouses divorce, each spouse keeps their retirement benefits without having to share those assets with their spouse. There are some conditions that can affect prenups, such as that the assets must be disclosed and the value of the assets at the time of the marriage must be honestly declared.

The vesting of the assets

“Vesting” refers to the time when the beneficiary (the spouse) can take some or all of the retirement assets and put that money into their own personal accounts. The type of retirement benefit determines when a beneficiary can take the assets and the specific requirements (such as forms that need to be filled out) for taking the assets.

Taxes

Another key factor that spouses and family lawyers need to consider is the tax consequences of retirement benefits. Some retirement accounts are designed to defer the payment of taxes until the beneficiary receives the money instead of when the retirement account is funded. The reason for this is that for many beneficiaries, their tax rate is much higher when they’re working full-time. Beneficiaries often take their retirement benefits when they’re not working or aren’t working full-time. Deferring the money until their earnings are less means that their tax rate is also lower.

Other factors that may affect the taxes on retirement benefits may include capital gain considerations, the type of investment, and other factors.

Our family lawyers can review the tax consequences since the IRS is entitled to its share (the taxes) before the remaining funds can be distributed to either spouse.

Trading assets

When our San Antonio divorce lawyers review your right to your spouse’s retirement benefits (and your spouse’s right to your retirement benefits), we consider all of your marital assets. While each spouse can receive their equitable share (such as 40, 50, or 60 percent) of each asset, a more practical approach is to trade off assets.

For example, if you have the right to 60 percent of the marital home, then you may agree to waive your right in any retirement assets of your spouse to keep 100 percent of the marital home. In this way, you and your children will own the family home in return for waiving your right to your spouse’s retirement benefits – assuming that the value of your share in the retirement accounts of your spouse is close to your spouse’s share in the family home.

Common types of retirement accounts

The most common types of retirement accounts are pensions, 401(k)s, and IRAs.

Distribution of pensions and 401(k)s

In Texas, our family lawyers obtain legal documents called “Qualified Domestic Relations Orders (QDROs).” The family court judge will sign a QDRO when there is an agreement between the spouses and their lawyers about what retirement assets should be divided, their value, and how they should be divided. Judges can also order a QDRO after litigation about the division of property.

A qualified employer retirement plan must be distributed to the ex-spouse only once the employer receives a QDRO.

Generally, a spouse (based on the QDRO) can receive their full share and deposit that share in their own accounts or use it for whatever purpose they want, or they can roll over the retirement account into their own retirement plan, such as their own IRA.

The spouse who receives retirement funds through a QDRO typically does not owe a tax penalty for an early withdrawal, but the funds are typically taxable as income. Whether a spouse receives the distribution or rolls over the distribution generally depends on how long the spouse can wait to use the funds.

IRAs (Individual Retirement Accounts)

According to Merrill Bank, IRA accounts are formally handled somewhat differently than pensions and 401(k)s. Like pensions and 401(k)s, the recipient spouse does not owe taxes if they roll over the assets, but may owe federal taxes if they take a distribution of the funds. According to Investopedia, there are some tax differences.

Roth contributions are funded with after-tax money and do not reduce your taxable income for the year. Although there’s no upfront tax break, withdrawals in retirement are tax and penalty-free under two conditions. (You must be at least 59½ years old, and you must have had the account for at least five years.)

With a traditional account, withdrawals are taxed at your income tax rate. Like with a Roth account, there’s no penalty for withdrawals as long as the distributions are made at age 59½ or older.

Some exceptions to the tax treatment of IRAs may apply. Generally, there are limits on how much anyone can place into their IRA account each year.

Social Security retirement accounts

Each spouse is typically entitled to their own Social Security retirement benefits. Spouses may be entitled to recover based on their ex spouse’s record if they were married for 10 years or more.

We can explain your right to your spouse’s Social Security retirement benefits if you divorce.

Beneficiaries

When the divorce is complete, you should consider removing your spouse as a named beneficiary. Your ex-spouse will still be entitled to his/her share based on the QDRO or any other divorce orders – but they won’t be eligible for any shares based on their beneficiary status alone.

Our San Antonio divorce lawyers advise spouses about all aspects of their retirement benefits and their spouse’s retirement benefits in the event of a divorce. Grable Grimshaw PLLC also negotiates prenuptial agreements. Call us today or use our online contact form to schedule a consultation.