Is your 401(k) now a 201(k)?

Currently American investors are seeing significant losses in the market. For most Americans the effects are being felt in their 401(k) accounts or mutual funds. (Hence the 401(k) to a 201(k) joke…I know it’s not very funny). In the long term, this downturn is just part of the market cycle, but if you are nearing retirement this can be very concerning.

In a divorce, other than homes, retirement accounts are often the biggest asset to divide. Most couples make contributions every month or year to their retirement accounts, so with the exception of short marriages, there is going to be a significant community interest in the accounts that must be divided. This includes defined contribution plans such as 401(k), 401(a) and/or 403(b). It also includes defined benefit plans such as pensions.

In a divorce, the Court uses the time rule to divide retirement plans. The time rule says (in layman’s terms) the community property portion of plan is a ratio. It is the time worked between the date the spouses are married and the date they separated in relationship to the entire time the plan holder was employed. This is the same for a defined contribution [401(k)] and a defined benefit plan (Pension).

This gets confusing since it is not simply a matter of deciding how much was contributed during marriage. If that were the case, you could look at a statement on the date of marriage and a statement on the date of separation and the difference would be community portion of the plan. Such a view does not account for the growth (or as we are seeing now) loss of the investment over time.

Another complication is that defined plans are governed by federal law (That is why it is called a 401(k) plan, it is reference to the Tax Code Section that authorizes the plan). Why is this a complication? Because your divorce is governed by state law. You see, for many reasons I won’t get into, state law and federal law do not play well together – there are tax issues at play as well that must be accounted for since most of these accounts are tax deferred money. As a result, you will be required to obtain a Qualified Domestic Relations Order (called a QDRO) or a Domestic Relations Order (called a DRO) depending on the type of plan you have.

Many family law attorneys do not prepare these types of orders and outsource the work to other attorneys. QDROs and DROs are complex and very specialized documents with very specific rules and regulations. For this reason, there are several firms or companies that deal exclusively with preparation of orders dividing pensions and other retirement vehicles.   Often times (I do this in almost every case); your Judgment of Dissolution will contain a provision that the parties will retain the services of a firm to prepare any necessary QDRO or DRO to divide a specific retirement plan. The provision will also include whether this cost (between $300-900) will be paid by one party or shared equally.

A qualified family law attorney will take the time to explain this to you, explain the costs associated with these orders and why it is necessary. There are many other issues that can come up when dealing with retirement accounts, such a survivor benefits that you should discuss with a qualified attorney, because failure to follow the rules related to these plans could result in you losing an interest you are entitled to.
