Retirement Benefits, Some Quick Info

The 10 Most Common DIY Divorce Mistakes & How to Avoid Them

There are three main areas regarding retirement benefits that many divorcing couples either do not realize or have questions and concerns.  First, many people do not realize that retirement benefits, acquired during their marriage, are a community asset, which California law will divide equally.  Second, many couples do not appreciate the tax consequences and other differences between retirement benefits and other assets that may affect their decisions in dividing their assets and debts.  Third, many people are unaware that there are mechanisms for dividing retirement benefits fairly and without adverse tax consequences.

 

Retirement Benefits can be Community Property:

 

Community Property, which California law divides equally upon divorce, includes retirement benefits from employment during the marriage.  It does not include retirement benefits from employment before marriage or after separation, which is Separate Property, nor does it include Social Security benefits, which are governed by Federal law.  Many people doing their own divorce do not realize that, legally, they are entitled to half of the retirement benefits from employment during their marriage.

 

Valuation & Tax Consequences of Retirement Benefits v. Other Assets:

 

Often when someone has been working for decades to amass retirement benefits, he or she becomes emotionally attached to those benefits and says something like, “I want to keep my pension, and the other side can have the house as an offset.”  Whether this plan is a good deal or not is complicated in a couple of ways.

 

First, the process of valuing a pension is different from valuing a house.  A house is appraised to determine the current fair market value, the current balance of any loans against the house is subtracted, and the difference is the equity in, or value of, the house.  A traditional pension, or “defined benefit plan,” which is a promise of a stream of payments in the future, is valued by an actuary who calculates the present value of the expected stream of payments based on a set of assumptions; most employees are shocked when their pension of a few thousand dollars per month calculates to a present value of hundreds of thousands of dollars.  Valuing a “defined contribution plan,” such as a 401(k), 403(b), or IRA, is much simpler, since the value is usually just the account balance on the most recent statement.

 

Second, retirement benefits and houses have very different tax consequences.  Retirement benefit funds, with some exceptions, cannot be accessed until retirement age, at least not without incurring tax penalties, and then they are taxed as income when they finally are received.  Equity in a house can be accessed now, tax-free, subject to some limitations, by selling the house or taking a loan against it.

 

Because retirement benefits and houses are valued and taxed differently, $1 in house equity is usually much better than $1 in retirement plan value.

 

How to Divide Retirement Benefits Fairly & Avoid Tax Penalties:

 

The process for dividing retirement benefits was defined by the Federal Government in the Employee Retirement Income Security Act of 1974 (“ERISA”).  Generally, a Qualified Domestic Relations Order (“QDRO”) is prepared, signed by the parties and the Judge, and submitted to the retirement plan.  If drafted correctly, the QDRO tells the plan to divide the retirement benefits appropriately, fairly, and without creating a taxable event.  Usually this means splitting the community portion of the benefits equally and either creating a separate account for the non-employee spouse and rolling the funds into it or just paying the non-employee spouse directly once benefits become payable, depending on the type of retirement benefit being divided.

 

We hope the above quick info on retirement benefits is helpful and informative.  It is not a detailed or comprehensive discussion of the subject.  You should not rely on the above information without first consulting an expert to determine how the current laws apply to your particular situation and circumstances.

 

The Law Office of Andrew J. McCall represents Family Law litigants in Contra Costa & Solano Counties, so, if you know someone who has been trying to do his/her own divorce and is having problems, have him/her contact us to discuss representation or consultation or just help with forms.