How Divorce Affects Social Security and Retirement Accounts

How Divorce Affects Social Security and Retirement Accounts

Divorce is a painful process.  If that is looming or you are contemplating, it is important to get organized with all assets.  However, the retirement accounts and claims on Social Security and Divorce are often the largest and trickiest to resolve.

A survey completed in 2017 found that 70% of married adults over that age of 37 do not have a financial plan in place to divide assets in a divorce. 

That may be romantic (sort of), but it’s naive.  43% of all marriages end in divorce, and the rate of divorce for couples that are over 50 is at an all-time high. 

Currently the average marriage lasts 8.2 years.

Prepare and Stock Cash

Money On Table

According to Kathleen Miller, CFP, it is very important to collect all financial information and start to plan a pre and post-divorce budget. 

When dividing assets don’t just contemplate total value but also consider the income that each asset produces.  

As Joe Dillon, MBA and Divorce Mediator, notes it is very important to account for your monthly cash flow needs

You do not want to end the settlement process asset rich and cash flow poor. 

That may require the couple to liquidate some assets so that there is a cash reserve to help launch your new independent lives. 

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Retirement Divorce Settlement

Divorce settlements are typically governed by state law and states generally fall into one of two categories–Equitable Distribution or Community Property. 

Equitable distribution is the more common of the two and generally follows that the property acquired during the marriage belongs to the person that earned it. 

At time of divorce that property would be divided in a “fair and equitable” manner.  It’s very much a case by case, and all facts are considered in making the allocation decision.

In Community property states all assets are assumed to be owned equally by both parties. This generally results in a direct 50/50 split between parties.

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Can My Spouse Get Half of My IRA in a Divorce?

Word IRA On Card | Social Security and Divorce

They answer is “Yes.” 

Typically all assets will be accounted for before making an allocation decision. 

For example, if the higher-earning spouse had two retirement accounts of $150k and $200k, and the other party had one account with $50k, the accounts would be summed and divided. 

In this case, $400k would be divided, let’s say 50/50, and each party would receive $200k.

In most states when contemplating the 401k divorce payout, the funds added to the account (and the appreciation recognized) during the marriage period is considered marital property. 

If you had a balance prior to marriage that would be treated as separate party and would be negotiated differently. 

Qualified Plans Require a QDRO in Divorce

Divorce is a time that you can get access to your 401k or IRAs funds and not pay an early withdraw penalty or tax. 

This is done via a Qualified Domestic Relations Order, which is a judgement that is made that recognizes an alternative payee’s rights to receive all or a portion of a payout from a qualified retirement plan.

This specific order (QDRO) is what allows the preferred treatment of this transfer. 

Often people going through a divorce will not take this incredibly important step and end up losing substantial funds to taxes and penalties. 

If you are dividing qualified retirement plans, make sure you are bringing this step to your attorney’s attention. 

The QDRO is required for all qualified plans under ERISA regulations.  Those plans include all defined contribution (401k, 403b, SEP, ESOP, etc.) and defined benefit (pension) plans.  

Read also: Is an ESOP a qualified plan?

Although serving the exact same purpose, the order that an IRA would go through is a called a ‘Transfer Incident to Divorce Event.’ 

That would be a separate act/order that would need to be pursued for the efficient transfer of IRA accounts.

Again, do not skip this step!

The final comment on QDROs is to ensure they are signed and finalized at the exact same time as the divorce proceeding. 

If one of the parties were to die or become incapacitated after the divorce but prior to the QDRO the funds would revert back to the standard withdraw process.

Pension Calculator in Divorce

Word Pension On Calculator

Dividing pensions at time of divorce comes with plenty of emotions. 

Often the person who has a pension has suffered through a long, dangerous career (fire-fighter, police, teacher) and feels entitled to the benefit. 

However, that is a windfall the supporting spouse also feels they are owed. 

Two of the most common formulas used to divide this income stream (divorce pension payout) is the Majauskas Formula or Coverture Fraction/Formula and both have these base components:

  • Y = Years of pension service during the Marriage.
  • T = Total Years of Credit at time of retirement.
  • Y/T = % of credit earned while married

With this as the baseline the couple will negotiate how to divide ‘credit earned during marriage’ portion. 

For example, let’s say the working period was 40 years, and the couple was married for 20 of those 40 years. 

The marital portion would be established at 50%.  If the Pensioner was receiving $48,000 per year, than the marital portion would be $24,000. 

That $24k would be subject to negotiation, and often we see that being split 50/50.

How to Keep Your Pension in a Divorce

Settling A Divorce

The best way to keep your pension in a divorce is to be ready to negotiate generously with the other marital assets. 

Every attorney, worth their fee, understands the value of a pension’s steady income stream, and there is plenty of precedence in spouses making (and getting) claims to those funds.

What has been successful is to liquidate some of the higher value assets and disproportionately share the windfall. 

For example, sell the house and net $300k, instead of splitting 50/50, allow the spouse to have the portion that is equivalent to 50% of the marital value of the pension.

Another approach is to do something similar with your more liquid assets.  Instead of splitting the taxable investment account evenly, give more generously. 

You can take this approach on the various marital assets until the receiving party is comfortable they are receiving their fair share.

Another idea is to purchase a life insurance plan that has an equivalent value to the defined-benefit of ex-spouse’s share of the pension. 

They would need to be named as the sole beneficiary.  Also, look at the terms of your specific pension plan. 

If the plan has a joint-life payout (continues to pay beneficiary after wage earner dies) and the ex-spouse were to remain the beneficiary that would have a lifetime value that should impact negotiations. 

Based on life expectancy if receiving spouse is expected to live 10-15 years longer and continue to receive a distribution those dollars ought to be brought back to the negotiation table before settling on any split.

Read Also: Best State Pension Plans

Social Security and Divorce

The best source for the rules on Social Security and Divorce benefit eligibility is the SSA directly. 

The linked resource page is dedicated to the topic and has an easy to read list of criteria. 

In short, you will be eligible at the time of divorce with social security benefits if you were married for 10 years, are not remarried, you are older than 62, and benefit you would receive based on your work history is less than an eligible portion of ex-spouse’s benefit.

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