How are retirement plans divided in a divorce?

What Is Marital Property?

Since retirement plans are subject to equitable distribution, it is imperative that you identify when the retirement plan was acquired. Marital Property in accordance with North Carolina law is real property (houses and real estate) or personal property (cars, furniture, etc.) that is acquired during the marriage and prior to the separation period. Since this property was acquired during the marriage, you can expect to share it during the distribution of your assets with your spouse. Everything that was purchased during the marriage is fair game for distribution. This includes the smallest items, such as salt and pepper shakers, up to important items like retirement plans. Separate Property is typically defined as property that is acquired prior to marriage, or property acquired during the marriage that is inherited by bequest or as a gift. Divisible property is property that changes value (increase or decrease) during the separation period and before the divorce decree.

Hybrid Property Value

Now that we have identified the types of property involved in equitable distribution, let’s talk about why they are important. It can be hard to believe, but one retirement plan can be considered marital, divisible, and separate property at the same time! For example, let’s pretend that you have a 401(k) plan that you began contributing to prior to being married. Let’s say that before the ink dried on the paper of your marriage license, your plan had matured and it was worth $10,000. The $10,000 would initially be considered separate property because it was not only acquired prior to marriage, but the maturity of that property was also prior to marriage. Now, let’s say that once you got married, you continued to contribute to that 401(k)  and prior to the filing for separation 10 years later. During your marital bliss, the 401(k) matured from $10,000 to $100,000. Is your spouse entitled to half of all of the money in your 401(k)? Not necessarily. The $10,000 that you accrued prior to marriage could remain separate property leaving $90,000 to be tossed into equitable distribution as marital property. Why did your property become marital? Because, the maturation of the 401(k) was conducted during the course of the marriage, the North Carolina courts consider the money contributed to be marital funds. See how important it is to distinguish the type of property the retirement assets are? You most certainly would not want to give your spouse half of $10,000 if it weren’t warranted, would you?

Now, after you filed for separation, let’s pretend that this 401(k) grew to $105,000. That extra $5,000 is also included, but since it was accumulated after the separation, it becomes divisible property. Still included in equitable distribution, just under a different category. As you can see, one retirement fund can be identified in more than one category.

How Valuable is your Retirement?

Not all retirement plans work the same. Because of the variations found in the retirement plans, the court has a formula to help separate the property appropriately. This equation, which is called the coverture fraction, ultimately helps to calculate the percentage of your pension or other retirement plans that can be categorized as marital property. This formula is usually used in circumstances where the property can easily be considered both separate and marital property. Let’s say that you have worked your entire life contributing to your pension. For 15 years prior to marrying the love of your life, you give more than the bare minimum to the plan. You then get married, and live in marital bliss for five years, only for the marriage to abruptly end in divorce. Maybe you need to consult your attorney about those Private Investigators we discussed in the previous articles. Or, maybe, life situations are leading you and your spouse in different directions. For purposes of this article, regardless of the rationale behind the split, you do not want your spouse benefitting from the 15 years of contribution to the pension for five years of marriage. Lucky for you, the court has implemented the coverture fraction. In accordance with this fraction, you would take the number of years that you were married (5). Divide it by the number of years that the pension has been in existence (20 — 15 years prior to marriage and 5 years during the marriage) and divide them. For purposes of this example, only ¼ of your pension plan is considered marital property, and your spouse is only entitled to ½ of that ¼, leaving them with 1/8 of the pension plan. That is much better than the standard ½ typically associated with equitable distribution.

Defined Benefit Plans

Defined benefit plans are much more difficult to assess because they are based on the employee’s salary at the time that they retire. If you and your spouse have 25 years of working in your future, the courts cannot simply use the current value of your benefit plans because that is not the “true value.” The court has configured a 5-step process by which they analyze the value of your defined benefit plans.

• Step 1: The Court will ask, “What is the earliest date that the spouse can retire?” Because retirement is not based solely on age, the court will look and see how much time you have invested in the company as well.
• Step 2: The court will use scientific data to analyze the life expectancy at the date of separation to determine how many months the employee-spouse should receive the benefits.
• Step 3: The court will look and determine the value of the pension at the earliest retirement date.
• Step 4: After configuring the date of retirement, the life expectancy, and the value of the pension plan, the court will discount the value to the date of separation (figure out the future value and discount that value to the date of separation).
• Step 5: Lastly, the court will determine whether there are any contingencies that may occur which will affect the plan and discount the value further if necessary.

Defined Benefit plans differ greatly from your traditional IRAs or pension plans, so it couldn’t hurt to hire an expert to ensure that the calculations are exact.

Retirement Plans-QDRO, Distribution, and More

So, we have identified the plan as marital property, subjecting it to equitable distribution. We have determined the percentage of the plan that will be divided between the spouses. It is now time to distribute those funds in a manner that will be equitable to both parties.

In most cases, the IRS allows for the distribution of funds subject to a divorce to be transferred tax-free. Even if there is no “legally binding” document, if the spouses can prove that the transfer was done incident to a divorce, typically the IRS will acknowledge this transfer and allow it to be conducted tax-free. Notice that this is in most cases, not all cases. Unfortunately, this IRS regulation is not all-inclusive and there are exceptions. In cases such as the transfer of retirement funds, tax events will automatically be triggered because separate tax laws surround the early withdrawal of 401(k) and pension plans. In other words, the tax event will be triggered because the retirement plan is being tampered with prior to retirement.  Incorrectly transferring funds subject to a divorce will not protect a retirement account from tax events, so it is important that you protect yourself from experiencing major tax penalties while trying to divide a retirement account between you and your spouse. There are ways to conduct this transfer so that it will remain tax-free, but you must adhere to a few simple rules.

• Step 1: Do not treat the transfer of IRAs as a “distribution”: Treating the transfer of an IRA as a distribution ultimately requires the withdrawal of the funds and then a change in ownership. The withdrawal ultimately triggers tax events resulting in major tax penalties for you. The party should simply transfer ownership of the account to their spouse, which will help them avoid tax penalties. In order to conduct this change in ownership, please be sure that the bank treats this as a “roll over” or just a “transfer.” Conducting the transfer in this manner will also prevent your spouse from transferring the funds into a tax-deferred IRA and avoiding being assessed the necessary taxes. Your spouse can also roll the funds into an already existing IRA account.
• Step 2: Beware of SEP-IRAs: SEP-IRAs have different benefits that the traditional IRA. They need to be transferred by using a Qualified Domestic Relations Order or QDRO. A QDRO is a type of legal instrument, submitted and signed by a judge granting an individual the authority to assign rights from their retirement account to another person’s retirement account. As long as the funds are deposited in another retirement account, the IRS will allow the account to be separated and withdrawn with no tax penalty to either party.  While QDROs seem like the sure way to transfer SEP-IRAs, you must be mindful that the QDRO itself requires a separate legal process. It is time consuming, and costly. Please be mindful that there are alternatives to accepting this type of retirement plan, and some spouses find themselves accepting other personal property in place of the retirement plan to cut costs.
• Step 3: Plans that are subjected to QDROs: Non-Qualified plans cannot be transferred by QDROs and because of their complexity are typically not assigned by a spouse during equitable distribution. Non-Qualified plans are employer-sponsored plans that do not adhere to ERISA guidelines. Typically, these plans are reserved for employees who either have specialized retirement needs, or are high-ranking and highly paid employees. They typically include express language, which prohibits them from paying any other person beside the employee, which places this plan out of reach during equitable distribution. Because of the language, and its failure to adhere to ERISA guidelines, typically a court order cannot force the plan to make payments directly to a former spouse from a non-qualified plan. Please receive sound counsel concerning these plans because in the event that a QDRO is used for a non-qualified plan, the recipient is often left with no recourse upon learning that their benefits cannot be transferred. This could result in other expensive litigation for you, which most people seek to avoid at all costs.
• Step 4: Is your Spouse Retired Military?: In order for a spouse to be paid out of Military Retirement, the “10/10” requirement must be met. The“10/10” requires that the spouses must have been married 10 years or more during which the military spouse had at least 10 years of applicable service. However, even if the “10/10” requirement has not been met, all hope is not lost. The court can still order a division of military retired pay. Once you determine that you are entitled, which most spouses are because military pay is considered a federal entitlement, a QDRO is not required to transfer the funds. All the spouse needs to do is to follow the Uniformed Services Former Spouses Protection Act (USFSPA) guidelines. The guidelines require submission of an application which will include a copy of the court order, certified by the clerk of court, and a completed DD Form 2293.
• Step 5: My Spouse Works for the Government: Federal Government plans do not adhere to ERISA guidelines, and as a result will not require a QDRO for the transfer of retirement benefits. The most popular Federal Government plans are Thrift Savings Plan (TSP). the Federal Employees Retirement System (FERS) and the Civil Service Retirement System (CSRS). Since the most popular plan is the TSP, we will discuss this plan at great length to provide a general understanding. Requirements for the other plans can be found at www.opm.com (for the FERS and CSRS).

The TSP does not require a QDRO for the transfer of benefits, but it does require what is called a retirement benefits court order. This order is very detailed, and must meet certain guidelines. The guidelines are as follows:

1. The order must be issued by a court in one of the 50 United States, or a United States territory.
2. The order must be clear on its face that it relates to a TSP. This is achieved by referring to the plan as a “Thrift Savings Plan.” Simply referring to the plan as a “government retirement plan” or “Federal retirement benefits” is insufficient.
3. The order must be clear regarding the dollar amount, fraction or percentage that the payee is entitled to.
4. The order can only require payment to the employee’s current or former spouse or the employee’s dependents.

As a final note, upon the transfer of your retirement benefits, make sure that you update your beneficiary information to exclude your previous spouse. The last thing some spouses want is for their ex to benefit from their retirement after death because they failed to make the necessary adjustments. Some companies will require you to submit “Life-Status Change” forms to make the change, but it will definitely be worth the extra effort.