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Dividing Retirement Plans During a Divorce

The law firm of Plog & Stein, P.C. practices solely family law in the Denver, Colorado area. As a divorce attorney in Denver, I handle all aspects of such cases, including the division of marital property. Though some have been depleted, or gone up and down and up and down over the last 3 years, many people still have retirement accounts that will need to be divided as part of the divorce process. This posting will focus on the division of three types of retirement plans: IRA’s, 401K’s, and pensions.

Though the Denver divorce lawyers at Plog & Stein, P.C. do not give tax advice, we do know a little bit about the subject as relates to divorce. Pursuant to the IRS tax code, transfers of property indicent to a divorce are generally not considered a taxable event. However, there are certain procedures that generally go along with the division of the above stated retirement accounts that are designed to ensure that the division does not become taxable.

IRA’s, or individual retirement accounts, are retirement accounts given certain tax status depending upon when funds are pulled out. If funds are pulled out before a certain retirement age, there may be tax consequences and penalties. In a divorce case, the marital portion of an IRA will need to be divided. If the plan holder just pulls out funds to pay his or her spouse out, he or she will be taxed and potentially penalized for the withdrawal. As such, the proper way for an IRA to be divided as part of a divorce is for the recipient to have the funds transferred or rolled over into another IRA or similar qualifying account set up for him or her. In this instance, the original plan holder is not taxed. Once the recipient receives his or her funds, he or she is free to do with them as he or she choose. If the recipient elects to cash out his or her funds, then a tax consequence and potential penalty may ensue.

401K’s are another type of retirement account often owned by parties to a divorce. A 401K is what is technically called a “defined contribution plan.” 401K’s are similar to IRA’s in that they are a lump sum account, with a cognizable value. As with IRA’s, when dividing up a 401K as part of a divorce, funds cannot just be withdrawn to pay the other spouse. Rather, 401K’s are generally divided through what is called a Qualified Domestic Relations Order, or QDRO. A QDRO is a specific order, ultimately signed off on by the court, instructing the plan or plan administrator to divide the 401K in a specific manner. Most plans have specific language that is required under the terms of the plan. The division of the 401K through a QDRO prevents the original plan holder from incurring tax or penalty consequences, which can be up to 40% of the withdrawal. The recipient of funds through the QDRO transfer can then elect to have his or her share put into a similar type of account or to cash them out via the transfer. Cashing out will lead to the tax/penalty consequence for the recipient on his or her share.

Most Denver family law attorneys dealing with property division do not actually draft QDRO’s. Why? Because they are very technicality laden and, frankly, most of us don’t know how. As such, in most cases, the actual drafting if farmed out to an expert QDRO drafter, whether an attorney or an accountant. The cost of the QDRO can range from roughly $400 to $800 depending on who is used, and is generally going to be split equally between the parties.

A pension is another type of retirement plan which authorizes a payment, generally monthly, to the plan holder after he or she reaches a certain age. Pensions are technically “defined benefit plans.” Unlike 401K’s and IRA’s, pensions do not generally have a readily known exact dollar value, though some do have a “lump sum” payout figure that the recipient can elect to receive should he or she decide to cash out the pension. Many people, including some attorneys, confuse the lump sum pay out figure with the pension’s value. This is wrong. Pensions can be valued by an expert, with a cost of generally $800 to $1000. In some cases, valuation of a pension may be practical, if there is off-setting property such that knowing the value leads to settlement or a dollar basis equalization of the assets. However, generally pensions will be divided, also through a QDRO, using what is termed the “time rule formula.”

The time rule formula sets for a certain mathematical equation for dividing the pension. As the pension doesn’t generally have a known present value, the formula factors in the marital portion and increases in the monthly amount to be received at retirement, thereby giving each party fair treatment from a monetary standpoint regarding the pension. The formula is as follows:

yrs. married/yrs. of service (x) marital fraction (generally 1/2) (x) monthly $ at retirement = the recipient’s monthly payment.

For example, if Bob was married to Sally for 5 years and works for IBM for an additional 15, and presuming the parties agreed to split the marital portion of Bob’s pension equally, and Bob receives $1000 each month at retirement, then Sally’s share of the pension, as per the time rule formula and QDRO would be as follows:

5/20 (x) 1/2 (x) $1000 = $125 per month as Sally’s share.

As shown by the formula, Bob’s non-marital share is allocated to him via the first fraction, and Sally is treated fairly by receiving her portion based on the amount to be received by Bob at actual retirement. Though the formula seems complex, it is actually quite simple to a family law attorney with experience in property division in divorce cases.

Your Denver divorce attorney can guide you as to the specifics of dividing your retirement property in a divorce and help you determine what is the most practical approach in your case.

Author Photo

Stephen Plog, co-founder of Plog & Stein, P.C. in 1999, is a dedicated family law attorney with almost two decades of expertise in Denver. Focused exclusively on family law since 2001, he excels in both intricate legal writing and courtroom litigation, having navigated cases in all Denver metropolitan area District Courts. Steve’s comprehensive background, including a Bachelor’s Degree in Psychology and a law degree from Quinnipiac University School of Law, underscores his commitment to providing insightful and personalized representation in family law matters.