401(k) Details Most Often Overlooked in Divorce

401(k) Divorce
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As a family law attorney, you are expected to know everything that needs to be known regarding the laws relevant to your clients. Unless you have unique training, you are not likely an expert in 401(k) plans.

Here are the top 401(k) pitfalls I’ve seen in divorce property divisions and how to best navigate them.



The Different Contributions

First, 401(k) plans nowadays have a lot of different types of contributions that are seen on a statement. You could have traditional contributions (pre-tax), Roth contributions (after-tax), employer match contributions and profit-sharing contributions.

You cannot lump all the contributions together to say the 401(k) is this total value. To be accurate, you would have to separate out what is pre-tax and what is post tax.

If there is an employer match is that pre-tax or after tax? It’s always pre-tax, even if the employee is making Roth (after-tax) contributions! For profit-sharing contributions, which are also pre-tax, you would also need to look at the vesting schedule to see what has vested and what has not. The vesting schedule is used as an incentive for the employee to stay with a company. For each year the employee stays, they will get a bit more of the money that is promised to them. A 401(k) statement will break out what has vested and what has not vested. If there is an unvested balance, it may show in their account, but it’s not theirs to keep until they stay for the entire vesting timeframe. The 401(k) plan can always provide the vesting schedule.

Clients need to understand the tax status of the different types of contributions. That way when the 401(k) is being split by a QDRO, the clients know what types of contributions will need to go into what types of accounts, matching the tax-status. For example, if there is a Roth 401(k) contribution (after-tax), that would go to a Roth IRA (after-tax). If you have traditional 401(k) contributions (pre-tax), that will go into a traditional IRA (pre-tax).

But clients frequently want 401(k) money to be put into an account they already own. What if a traditional 401(k) (pre-tax) is being split and the client wants it all to go to their Roth IRA (after-tax)? If the client moves that pre-tax money into a Roth, that will be a taxable event in the year they do it. It’s OK to do it, but they need to understand the potential tax ramifications of that decision. It’s super important to be able to advise your clients on the tax consequences of their actions so that they can make informed decisions.

401(k) Loans

What happens if there is a 401(k) loan? A 401(k) loan is money that is borrowed from your 401(k) balance and is repaid from salary deferrals (or paycheck deductions). Identifying the loan on the statement is important because the stated balance eligible for division is always minus the loan amount. Any amount that has not been repaid by the time of the QDRO can NOT be divided. You can not transfer a loan balance to a third party.

Speaking of QDROs, 401(k) plans have general rules that pretty much apply to all plans, but there are also plan specific rules. If the QDRO is not written per the terms of that specific 401(k) plan, the plan administrator will reject it. Do the due diligence to find out the details for your client BEFORE costly mistakes are made.


Computer Forensics


Another point with 401(k) plans and QDROs. There are times when clients may need to take a distribution from a retirement account to pay various expenses, down payment on a house, etc. The when, and from what account, is very important. Per IRS rule72(t)(2)(c), the 10% early withdrawal penalty is waived if taking a distribution from a 401(k) plan to an alternate payee under a QDRO. This rule does not apply if the client has rolled the 401(k) money to an IRA. It’s important to know if the client needs money from the account so you can advise them to take it from the 401(k), and not to roll it over into an IRA. This rule also has no limit on the number of penalty free distributions that they can do! Once a client reaches age 59 ½, then it doesn’t matter anymore whether they leave the money in the 401(k) or roll it to an IRA. After age 59 ½, the early withdrawal penalty goes away. It absolutely adds value if you can have the right experts to advise your clients on this appropriately and save them money on taxes!

Should attorneys be taking on the risk of advising on the financial issues of divorce? I know most do not and would not. Consider transferring the risk to a qualified financial professional who can advise the clients properly and ensure that mistakes are avoided.

Kim Surber

Kim Surber, a Certified Financial Planner® and a Certified Divorce Financial Analyst® has 21 years of experience as a financial advisor. Kim provides her divorcing clients with financial expertise to ensure optimal settlement outcomes. Divorce does not have to be confusing, costly and overwhelming. Kim works side-by-side with her clients to create clarity and confidence before, during, and after divorce. Kim partners with attorneys to create the reports and exhibits for a rock-solid case! For more information, visit LeewardDivorcePlanning.com or email [email protected].

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