Your 403(b) or 457 plan may represent a significant portion of your household assets. If you are going through a divorce, there’s a good chance your plan will be part of the divorce settlement. You’ll want to know your rights regarding your plan and your spouse’s retirement plan, if applicable, and how you can help protect plan distributions from unnecessary taxes.
Dividing Your Plan
Usually, the funds in a 403(b) or 457 plan accumulated during a marriage are considered the marital property of both the husband and wife. Generally, laws do not require that retirement plan itself be divided, as long as the spouses get equitable assets. For example, a settlement may state that the plan participant retains the 403(b) or 457 plan’s assets, and the other spouse is awarded other assets, such as the house.
Before heading to court, it’s a good idea to determine the value of your assets. Take into consideration your 403(b) or 457 plan’s potential for future growth vs. that of your other property, plus associated taxes and fees. To find out your current balance, check your most recent account statement.
Easing the Tax Pinch with a QDRO
For the division of your plan or your spouse’s plan to be included in the settlement, one of the parties needs to request it as part of the divorce proceedings. A separate court order, called a qualified domestic relations order (QDRO), must be obtained. The QDRO ensures that the plan sponsor recognizes a nonemployee spouse’s right to a portion of the plan after divorce. Once the court issues the QDRO, naming the nonemployee spouse as alternate payee, a copy must be sent immediately to the plan administrator.
A qualified QDRO must contain certain information, including the amount of the proceeds and when they should be paid. It also must not conflict with any of the plan’s restrictions regarding payout options and timing of the payout. If there are conflicts with the QDRO, the plan sponsor can declare that the QDRO is unenforceable and you’ll need to go back to court to get the order revised.
Transferring the Money
Once the divorce is final, the QDRO allows the plan to transfer the portion of funds allowed by the court into an individual retirement account (IRA) for the nonemployee spouse. By doing so, the money retains the tax-deferral benefit. The funds are also excluded from the additional 10% penalty that normally would be incurred with an early withdrawal from a qualified retirement plan.
With the QDRO, a portion of the plan payment could also go directly to the nonemployee spouse rather than into an IRA. This may be necessary to pay expenses, such as attorney fees. However, be aware that, although there still would be no 10% tax penalty, any portion of money not transferred immediately into an IRA becomes taxable for that year.
If a divorce may be in your future, it’s a good idea to check with your district for details about your plan’s payout options. You’ll also want to consult a tax attorney and other experts to get a better understanding of your financial rights and obligations.