Retirement plans and tax-deferred assets offered by your employer are an ideal way to save for the future. But what if your future no longer includes your current spouse? Clients often ask what happens to such employment related assets in a divorce settlement. Here is the general bottom line in Arizona:
Defining Community Property
Any vested, tax-deferred assets acquired during marriage, for example, pension, retirement, or 401(k) plans, are considered community property. Therefore, they are subject to being equitably divided in a divorce. (“Vested” means your right to the benefit or asset will not be forfeited if your employment relationship terminates before your retire.) If part of your plan assets or entitlements were accumulated before your marriage, but contributions continued during the marriage (including employer contributions), only the assets or entitlements accumulated during the marriage are considered community property.
How Assets Are Divided
Many tax-deferred plans connected with employment require a Qualified Domestic Relations Order (QDRO) in order to be “divided.” A QDRO is a separate order entered by the judge at the time of your divorce, which directs the administrator of your plan to divide the assets according to the decree. A QDRO allows such division without penalty or taxes that might otherwise occur if monies were withdrawn from the plan outside of a divorce context.
Depending on the type of plan being divided, your spouse may receive his or her share of the plan immediately, or they may have to wait until you are allowed to begin receiving distributions from the plan. Other tax-deferred accounts, whether acquired in connection with your employment or not (such as an IRA), may not require a QDRO, but can still be divided without penalty or taxation if they are divided because of a divorce.
Another common benefit subject to division in a divorce is employee stock or stock options. Again, if the option grant occurred during the marriage, the options or stock purchased with the options are community property. Although some stock plans may be divided via a QDRO, other provisions may need to be made for the division of unexercised options, as many companies do not allow their transfer.
Obtaining Legal Counsel
Although legal representation is essential in any divorce proceeding, there are specific reasons that counsel should be sought when it comes to tax-deferred assets. Here are some of the most important:
- Because the granting, vesting, and exercise of such options vary greatly between companies
- Because the grants may occur for different reasons
- Because the reason for the grant may affect whether the options belong to the community
Remember, if you want to keep your plan assets in exchange for some other community asset, you must remember to “tax effect” the value of the plan, stock, or stock options you are receiving. The $100,000 in your pre-tax 401(k) plan is not equal to the $100,000 equity in your marital residence.
At Hallier Stearns PLC, we have years of experience protecting clients’ assets and interests during a divorce. Contact us to learn more about our services and how we can help.