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Divorce mistakes that can negatively impact the value of retirement accounts

many divorce-related changes in your life occurring simultaneously, finances are typically top-of-mind. As you attempt to budget for and adjust to a reduced monthly income and new housing costs and bills; it's important to keep these types of new financial responsibilities in mind when negotiating a divorce settlement.

In addition to a family home and any assets held in banking and savings accounts; assets held in retirement accounts are typically among the most valuable that an individual and couple has. It's important, therefore, to know what types of retirement accounts both you and a soon-to-be ex-spouse have, the value of these accounts and the rules that apply when such accounts are transferred, accessed and taxed.

 

Failing to understand the specific rules that apply when dividing assets held in Individual Retirement Accounts and/or 401(k)s can have significant and unintended consequences including hefty tax penalties. For example, the transfer rules that apply to IRA assets differ from those that apply to assets held in 401(k)s.

While IRAs are divided via a process "known as transfer incident to divorce," 401(k) assets are divided using a "Qualified Domestic Relations Order." This distinction is important and should be clearly noted in a divorce settlement along with the specific account numbers and amounts that are to be transferred to an ex-spouse.

When done correctly, the spouse who receives IRA assets may choose to roll the assets over into his or her own individual IRA. He or she may also elect to cash out or take distributions from the IRA. Depending on an individual's age, these types of actions typically signal hefty tax penalties which could dramatically reduce the amount of an individual's settlement.

When it comes to the division of retirement assets and divorce, it's important to consult with an attorney who is well-versed in these and other divorce-related financial matters. An attorney will ask questions to determine your short and long-term financial goals and work to broker a divorce settlement that helps you reach these goals.

Source: Investopedia, "Divorcing? The Right Way to Split Retirement Plans," Mark P. Cussen, June 9, 2016

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