Julie and Pete are in their mid 50’s and have decided to divorce. Both are worried about the affect a divorce will have on their retirement. Julie fears that she may not be able to afford to retire and Pete has concerns that he may have to push retirement back several years. Both wonder if there is a way to divide their retirement assets with a minimal amount of financial damage. Marilyn Timbers, in her article 4 Divorce Mistakes That Can Derail Retirement, raises four issues that may affect Julie’s and Pete’s retirement after divorce.

Should Julie give up her interest in Pete’s retirement in exchange for keeping the marital home? 

Often times a spouse believes it is better to keep the house rather than receive a portion of their spouse’s retirement. However, this is not always true. Julie needs to consider the cost of maintaining the home as well as its future value. If Pete’s retirement plan is well diversified, Julie may be better off receiving the retirement income. It is also important for Julie to consider the tax consequences of receiving either asset before signing an agreement.

Are all retirement accounts the same?  How are the accounts impacted by taxes?

Pete believes that it is fair for each of them to keep their own IRA accounts because they have the same value.  Pete has not considered the tax implications of this arrangement. While both accounts may have the same value, his IRA is a pre-tax account and Julie has a Roth IRA, a post-tax account.  If they were to each keep their own account, the division would not be equal due to tax consequences at the time of withdrawal; Pete pays taxes at withdrawal and Julie does not.  It is important for Julie and Pete to consider the value as well as the tax status of all of their retirement accounts.

If Julie needs cash should she take a withdrawal simultaneously with the rollover of retirement funds from Pete to her, or should she do it later?

Julie rolls her share of Pete’s 401(k) into her IRA immediately after divorce even though she needs cash to pay for divorce related expenses.  If Julie withdraws funds from her retirement prior to age 59 ½ there is a 10 percent tax penalty; however since her share of Pete’s 401(k) is allocated to her under a Qualified Domestic Relations Order (QDRO), she is entitled to a one time opportunity to withdraw money from Pete’s 401(k) without owing the penalty. Once the rollover from Pete’s 401(k) into Julie’s IRA occurs, she will be subject to the ten percent penalty should she need to withdraw the funds early.

 Should Julie decide to take all of Pete’s 401(k) in cash, rather than rolling over the funds into her own retirement account?

Although Julie has the ability to withdraw funds from her portion of Pete’s 401(k) without incurring the ten percent penalty, she should not withdraw more than she needs. While immediate cash will help Julie now, she may be sacrificing her retirement down the road. Julie needs to assess her current and future cash flow and determine how much she will need for retirement before she determines how much, if any, of Pete’s 401(k) she should withdraw rather than rollover into her IRA.

It is important for Julie and Pete to discuss these issues with both their legal and financial advisors before entering into an agreement with regard to dividing retirement assets.

(11/04/13)