By Ellen Hoffman
When you're getting a divorce, retirement finances may rank far below the disposition of your home, child custody, and other issues on the table. Yet how retirement assets are divvied up in a divorce is an issue that potentially affects millions of Americans. According to the U.S. Census, in 2001, 41% of men and 39% of women aged 50 to 59 had been divorced at some point, as had nearly a third of men and women in the 60-to-69 age bracket.
Decisions about what to do with 401(k)s, IRAs, deferred compensation, and other potential retirement assets can—and sometimes do—literally make or break one or both spouses' retirement dreams. Even in cases where the spouses reach an amicable settlement, the ultimate distribution of retirement assets can be skewed due to failure to understand the laws that govern retirement plans and the uncertainty of the future value of the benefits.
So how can you protect yourself from losing your retirement security in a divorce? There are four main steps: Inventorying all of your assets, finding out the rules and laws that govern how they may be divided, assessing the present and future value of the assets, and negotiating an agreement.
If you are getting a divorce, Lila Vasileff says you should start by making and safeguarding copies of all your financial records, and compose a "marital history" listing where you and your spouse worked, retirement benefits from the jobs, and other assets such as IRAs. Specify which assets you each brought to the marriage, because in some states, you will be able to keep these out of the "pot" that you're dividing.
David Bergmann, a financial planner in Marina Del Rey, Calif. says in listing assets you should "think globally," including stock options, deferred compensation, and any other current or potential income that may not be labeled a retirement account but could generate retirement income.
Next, learn the rules that govern who can use each type of asset, when, and under what conditions. If you have a traditional IRA, you can agree to split the money in it. But if you're receiving money from your ex's IRA, make sure the bank or brokerage holding the new account knows it has been agreed to in the divorce so that you avoid paying income tax and a 10% early withdrawal penalty on it. (If you are older than 59 ½, there would be no penalty. With a Roth IRA, there is no income tax because it was paid before the money went into the account.)
You also can divide up the money from a 401(k) or a traditional pension from a private employer, but this is more complicated. In addition to your divorce decree, federal law requires you to get a Qualified Domestic Relations Order (QDRO) that specifies the terms of the division. Pension experts say that failure to get a QDRO drafted along with or soon after the divorce, and errors in drafting, account for a spate of problems for non-employee spouses who planned to receive some of their ex's retirement benefits. In one case Vasileff is familiar with, while the spouse's lawyer delayed six months in drafting the QDRO, the employed spouse was hit by a car and died. Without the approved document, the ex could not claim a penny of the pension.
With a defined-benefit pension, there are two main approaches to dividing the bounty. One strategy is to take a lump sum out of the pension fund and give it to the non-employee spouse immediately. If allowed by the plan rules, this can be done without a tax bite, and can provide some immediate aid to a spouse who's in a cash crunch.
The other strategy, known as "if, as, and when," is to postpone taking your share of your spouse's pension. The benefits of doing this include being able to count on the future income stream and assuring that you don't fritter it away before retirement. But Vasileff points out some disadvantages: The company could do an Enron, and you might lose some or all of the benefit; you'll have to pay taxes on it in the future; and if your spouse dies before retirement, you might lose the benefit entirely.
If you have assets such as stock options and deferred compensation in a non-tax-qualified plan, Bergmann recommends hiring an expert in pension valuation to help determine their real current and future value. Learning the rules for gaining access to these pots of money also is crucial.
If your divorce decree awards future benefits from your ex's deferred-compensation plan and then your ex changes jobs, you could lose income you planned on for your retirement. Receiving stock options in a settlement could also present problems. The company may allow the options to be exercised by the employee only. So you might have to wait for the money, stay in touch with your ex until the money is paid out even if you prefer not to, and of course, the value of the options could plunge.
The final step is usually the stickiest: negotiating a settlement. Keep in mind as you negotiate that along with IRAs and pensions, retirement assets can include the family home, other real estate, business assets, and just about any other type of property you can think of. Any or all of these may be fair game for trade-offs to help your retirement nest egg. Once you've signed the divorce papers, it is very difficult to reopen the agreement, even if you don't think it was fair.
Whatever happens, don't waste time arguing over how to divide the most basic of retirement benefits—Social Security. Cindy Hounsell, executive director of the nonprofit Women's Institute for a Secure Retirement in Washington, D.C., says many people do not realize that Social Security benefits are guaranteed and not negotiable: You and your spouse are each entitled to your own benefit based on your work record or your spouse's earnings. The criteria to be eligible for your spouse's Social Security benefit after a divorce are: you need to have been married to the spouse for at least 10 years, you are at least 62, you are unmarried, and you are not entitled to a higher Social Security benefit based on your own record.
Provided you meet those requirements, no one—not even your ex spouse—can take any of that amount away from you.
In addition to writing Your Retirement for BusinessWeek Online, Hoffman is the author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement with Help from Uncle Sam. You can contact her through her Web site, www.retirementcatchup.com