How to Protect Your 401(k) In a Divorce

How Are 401(k)s Split During a Divorce?

The 401(k) of a divorcing couple can be split depending on several factors including:

  1. including where they live,
  2. the balance of each 401(k),
  3. how the government taxes the 401(k), and
  4. the value of other marital assets

Marital property is divided equitably in most states, which implies that marital property must be split equally unless there are exceptional circumstances.

In a divorce, marital assets must be divided 50/50 under community property rules. This means that any money you deposit into your 401(k) before marriage is not considered marital or community property and isn’t subject to division in a divorce.

A court may order one spouse to give some of his or her money to the other if the one with more savings has significantly more money. But that does not necessarily imply that you must liquidate your 401(k) and give part of it to your ex.

How to Protect Your 401(k) In a Divorce

401(k) accounts are a great tool for retirement savings. If you have a 401(k) and you get divorced, or if your soon-to-be ex has one, knowing how to protect your 401(k) can be vital to ensuring a successful outcome.

Your main concern in a divorce should be covering all of your living expenses. You don’t want to end up in a situation where you have to raid your retirement savings in order to make ends meet. To protect your 401(k), you’ll need to take a few steps:

1. Keep the account in your name.

If the account is in your name, your ex can’t touch it without your permission. However, if you’re still employed with your company, don’t remove the money. Keep it in your account until you retire or leave the company.

2. Consult an attorney.

Your attorney can help you transfer ownership of the account to your spouse while avoiding taxes and penalties. This is known as a Qualified Domestic Relations Order (QDRO).

3. Keep a receipt.

If you move the 401(k) out of your name, be sure to keep a copy of the plan’s Summary Plan Description (SPD) and a record of where the 401(k) is now. This way if your ex-spouse makes any claims later on, you have proof that the account is no longer in your name.

What Happens if You Don’t Take Steps to Protect Your 401(k)

If you don’t take steps to protect your 401(k) in a divorce, your ex-spouse could potentially drain it or use it to pay off their own debts. This could have a serious impact on your retirement savings. By taking the steps outlined above, you can help ensure that your 401(k) goes towards your golden years.

What Is 401(k) Hardship Divorce Withdrawal?

If you are ordered by a court to give money to your ex-spouse or children, you can withdraw funds from your 401(k) without paying the 10% penalty fee if you qualify for a hardship withdrawal.

Should You Stop Contributing to a 401(k) During Divorce?

Whatever you decide, you’ll need to verify your plan to see whether you can modify your plan enrollment status or contribution amounts within the time frames provided. Some people find that stopping retirement contributions when a divorce is being prepared helps them to save money on attorneys’ costs.

However, keep in mind that whatever you spend after the date of separation is likely to be your separate property.

Who Can Help You With This Process?

If you need assistance protecting your 401(k) in a divorce, consult an attorney. They can help you transfer ownership of the account to your spouse while avoiding taxes and penalties. This is known as a Qualified Domestic Relations Order (QDRO). Attorneys typically charge by the hour, so be sure to get an estimate before hiring one.

The Bottom Line

To learn more about protecting your 401(k) in a divorce, consult an attorney. While you can transfer the account to your spouse without penalty, be sure to get help if you’re not familiar with transferring assets. This way, you can protect yourself during what is often an already stressful time.

If the 401(k) account is in your name, your ex-spouse cannot touch it without your permission. If you are still employed with the company, don't remove the money from the account - keep it until you retire or leave the company.
If you don't take steps to protect your 401(k) in a divorce, your ex-spouse could potentially drain it or use it to pay off their own debts. This could have a serious impact on your retirement savings.
A Qualified Domestic Relations Order (QDRO) is a court order used to transfer money from your retirement account, such as a 401(k), to someone else. If you want to transfer ownership of the account to your spouse, you'll need an attorney's help for this process.
You can avoid paying the 10% penalty fee if you qualify for a hardship withdrawal. To do this, you'll need to provide documentation that shows you meet one of the IRS's conditions for a hardship withdrawal.
Attorneys typically charge by the hour, so be sure to get an estimate before hiring one. You can also consult with your plan administrator to see if they offer any assistance or guidance.

401(k) Plan | A Complete Beginner's Guide

401(k) Meaning

The 401(k) retirement savings account got its name from the Revenue Act of 1978, where an addition to the Internal Revenue Services (IRS) code was added in section 401(k). Consequently, 401(k) does not stand for anything except for the section of IRS tax code it was created in.

Traditional 401(k) vs Roth 401(k)

There are two types of 401(k) plans: Traditional and Roth 401(k)s. The traditional 401(k), named after the relevant section of the IRS code, has been around since 1978. With this plan, any contributions you make to the 401(k) account will reduce your income taxes for that year and will be taxed when they are withdrawn. Roth 401(k)s, named after former senator William Roth of Delaware, were introduced in 2006. Unlike a traditional 401(k), all contributions are made with after-tax dollars and the funds in the Roth 401(k) account accrue tax free. Typically, employees can take advantage of both plans at the same time, which is recommended among financial advisors to maximize retirement savings. Because of the way the contribution limits work, it is possible to invest different amounts into each account, even year-to-year, so long as the total contribution does not exceed the set limit.

Contributing to Your 401(k) Retirement Plan

Contributing to a 401(k) plan is traditionally done through one’s employer. Typically, the employer will automatically enroll you in a 401(k) that you may contribute to at your discretion. If you are self-employed, you may enroll in a 401(k) plan through an online broker, such as TD Ameritrade. If your employer offers both types of 401(k) accounts, then you will most likely be able to contribute to either or both at your discretion. To reiterate, with a traditional 401(k), making a contribution reduces your income taxes for that year, saving you money in the short term, but the funds will be taxed when they are withdrawn. With a Roth 401(k), your contributions can be made only after taxation, which costs more in the short term, but the funds will be tax free when you withdraw them. Because of this, deciding which plan will benefit you more involves figuring out in what tax bracket you will be when you retire. If you expect to be in a lower tax bracket upon retirement, then a traditional 401(k) may help you more in the long term. You will be able to take advantage of the immediate tax break while your taxes are higher, while minimizing the portion taken out of your withdrawal once you move to a lower tax bracket. On the other hand, a Roth 401(k) may be more advantageous if you expect the opposite to be true. In that case, you can opt to bite the bullet on heavy taxation today, but avoid a higher tax burden if your tax bracket moves up. Check out this article from Forbes to see the IRS tax rate tables for 2020, but remember that they are subject to change. A smart move may be to hedge your bets and divide your contributions between the two types of IRAs. If your employer allows you to add funds to both a traditional and Roth 401(k), then doing so reduces the potential risks of each. In this case, you will also have the ability to decide what proportion of your income goes into each account, meaning that as you near retirement and have a clearer idea of what position you will be in, you can put more into one or the other. When you do decide which avenue to take, make sure to thoroughly evaluate your decision. Moving funds from one account to another, such as from a traditional to a Roth 401(k), is time consuming and expensive, if even possible. Likewise, transferring a 401(k) from one employer to another in the event of a job change is also tricky. You want to make sure that when you put money into your plan, it will be able to sit undisturbed for a very long time.

Pension vs 401(k)

Pensions are similar to a 401(k), but are a liability to a company. If an employer offers an employee a pension, it means that they are promising to pay out a set amount of money to the employee at the time of their retirement. There is typically no option to grow this amount, but it also does not require any financial investment from the employee. Pensions, also referred to as defined-benefit plans, are becoming increasingly rare because it puts the financial burden of offering a retirement fund for employees entirely on the employer. 401(k)s, which are also called defined-contribution plans, take some of the financial pressure off of an employer, while also allowing employees to potentially earn a larger retirement package than they would have with a pension.

How Much Should I Contribute to My 401(k)?

Most financial experts say you should contribute around 10%-15% of your monthly gross income to a retirement savings account, including but not limited to a 401(k). There are limits on how much you can contribute to it that are outlined in detail below. There are two methods of contributing funds to your 401(k). The main way of adding new funds to your account is to contribute a portion of your own income directly. This is usually done through automatic payroll withholding (i.e. the amount that you wish to contribute, counting all adjustments for taxation, is simply withheld when receiving payment and automatically put into a 401(k)). The system mandates that the majority of direct financial contributions will come from your own pocket. It is essential that, when making contributions, you consider the trajectory of the specific investments you are making to increase the likelihood of a positive return. The second method comes from deposits that an employer matches. Usually employers will match a deposit based on a set formula, such as 50 cents per dollar contributed by the employee. However, employers are only able to contribute to a traditional 401(k), not a Roth 401(k) plan. This is especially important to keep in mind if you want to utilize both types of plans. A key variable to keep in mind is that there are set limits for how much you can add to a 401(k) in a single year. For employees under 50 years of age, this amount is $19,500, as of 2020. For employees over 50 years of age, the amount is $25,000. If you have a traditional 401(k), you can also elect to make non-deductible after-tax contributions. The absolute limit, counting this choice and all employer contributions, is $57,000 for employees under 50, and $63,000 for those over 50 as of 2019.

Plan in Advance

Allow us to help you prepare and plan for your retirement ahead. Contact a financial advisor in St Helena, CA or visit our financial advisor page for other details.

401(k) Plan FAQs

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

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