Don't Ignore 403(b) in Divorce
If you're getting a divorce, the last thing on your mind may be a retirement account. But you should make sure you get your fair share of this important asset.
If you have a 403(b), you (or your lawyer) need to know how to divide it equitably and preserve the tax advantage. If you don't have a 403(b), but your spouse does, you and your lawyer should understand what to do in order to receive a portion of the account, and what you can do with the money.
"If your spouse has a 403(b), it's important to be savvy enough to recognize the 403(b) for what it is and make sure you get a fair share of it," said Sheila Wilson, director of technical services at Diversified Investment Advisors.
You should find a divorce attorney who is knowledgeable about splitting retirement accounts. Some people going through a divorce enlist the help of a certified divorce planner -- a financial planner trained to evaluate the potential impact of financial decisions made during the divorce.
Here's a look at the issues you should know if you're splitting a 403(b) in a divorce.First Step
If the 403(b) belongs to your spouse, you are known as the "alternate payee." The first thing you (or your attorney) should do is make sure the 403(b) is included in the divorce agreement that portions out marital assets.
"A 403(b), like any marital asset, is up for grabs," said Wilson. "You need to establish that the 403(b) is part of the assets that need to be split."
Don't assume your estranged spouse, the account owner, will be generous enough to think of including the retirement account in the marital assets. "In most cases it's the alternate payee who has to bring it to the attention of the attorney," said Wilson.
If each party has a retirement account, the divorcing couple may agree simply that each will keep his or her own account. But if one party has a much bigger retirement account, a portion may be transferred to the person with the smaller account. This needs to be negotiated as part of the divorce settlement.
In terms of what constitutes an equitable split, "everything varies dramatically by state" and even by jurisdictions within the state, said Jacqueline Gold, executive director of the Institute for Certified Divorce Planners. "It's very important for people to have an attorney who can guide them through what's allowed."
Certified divorce planners can advise a client on the potential future benefit of a retirement account compared to another asset such as a house, said Gold. A retirement account may not look as important on paper now as it does when you look at projections 20 years into the future, she said.The Basics
If the 403(b) will be split, the account's special tax-deferred nature can only be protected if it's divided through a Qualified Domestic Relations Order (QDRO).
A QDRO is a court order, signed by the parties to the divorce agreement and the judge, laying out the conditions for splitting the account. When completed, the QDRO is sent to the 403(b) plan administrator, who can then split the account and do what's required with the money. However, the administrator first has to determine whether the QDRO is valid. Reasons it might be invalid include unclear language, missing information, or a stipulation that money be distributed in a way that the plan doesn't allow. If the QDRO isn't acceptable, the plan administrator sends it back to the attorneys, who have to correct it and move it through the legal system again to get it approved by all parties. This costs time and money. That's why it's so important to get the QDRO right the first time.
When it becomes clear you are going to be divorced, you or your attorney should contact the 403(b) plan administrator right away.
"Contact someone at your benefits office at work, or at the 403(b) provider, and get the information from them about what can be done," said Ken Stein, second vice president of counseling and correspondence services at TIAA-CREF. Many plan administrators, including TIAA-CREF and Diversified Investment Advisors, provide a sample QDRO and other information for guidance.
You might wonder why you should go through the hassle of obtaining a QDRO. Why not just take money out of the account and give half to your ex-spouse?
There are a couple of reasons.
First, you may not be eligible to simply take money out of your plan (known as a distribution). In return for the tax break you get for contributing to the account, there are restrictions on accessing your money. You can only take a distribution if you have what's known in benefits lingo as a "distributable event." These include leaving the company or reaching a specified "normal retirement age" like 60 or 65. Getting a divorce is not a distributable event, but obtaining a QDRO is.
Second, if you do take a regular distribution (if you're eligible), you'll owe tax on the whole amount, plus a 10 percent early withdrawal penalty if you're younger than 59 1/2. If it's your account, you'll be liable to pay the taxes, even if you give the money to your ex-spouse.
The QDRO ensures that the money can remain tax-deferred.QDRO Distribution Choices
How you want to receive the money from your ex-spouse's 403(b) must be spelled out in the QDRO. You normally have a choice of what to do with the money. Generally, the options include rolling the money into another tax-deferred retirement account, such as an IRA or 401(k), leaving it in the 403(b) plan as a separate account from your ex-spouse's, or taking a cash withdrawal as a lump sum or over time. What you are allowed to do depends on the rules of the 403(b).
If you roll the money over, it will fall under the distribution rules of the plan you roll it into. If you move it to an IRA, for example, it will be governed by IRA distribution rules. (This means, for one thing, that if you want to withdraw the money before you turn 59 1/2 you'll owe a 10 percent early withdrawal penalty in addition to regular income tax unless you qualify for an exception.)
If you leave the money in the 403(b), the tax advantage will also be preserved. You'll have the right to make withdrawals according to the rules of the 403(b). You'll owe income tax on the withdrawals, but the early withdrawal penalty won't apply, Wilson said.
If you decide to withdraw the cash from the 403(b), remember that you'll owe income tax on the entire amount you receive. (You won't owe the 10 percent early withdrawal penalty, though, no matter what your age, because you got the money through a QDRO.)
You might be able to combine these choices -- for example, by taking part of the account in cash and leaving the rest in the 403(b) or another tax-deferred account, in order to keep some retirement savings intact.Potential Pitfalls
The tricky part about splitting a 403(b) is ensuring that it's done properly to minimize taxes and hassle.
"One thing that's very problematic is when the QDRO is drafted poorly," said Wilson. Required information may be missing, or language explaining what percentage the ex-spouse should receive, and on what date the account should be valued, may be vague.
"If you mean the ex-spouse should get 50 percent of the value as of June 24, 2002, then you should say that," said Wilson. "It has to be very clear."
Another problem that may crop up is if the attorneys don't do their homework, and assume a plan allows a certain type of distribution when it actually doesn't, said Gold.
It's essential for the attorney to find this out ahead of time. Otherwise, a finalized divorce agreement may need to be renegotiated from square one, to split the assets differently from what was originally agreed.
"It's a big mess," said Gold.Other Things to Remember
Remember to keep your beneficiary designation up-to-date. Most people name their spouse as the account beneficiary. (If they don't, the spouse needs to sign a waiver in order for someone else to be named.) If you have a 403(b) and your spouse is named as your beneficiary, remember to file a form naming a new beneficiary once you're divorced, unless you want your ex-spouse to get the money if you die, said Stein of TIAA-CREF.
Also, don't wait too long to start planning your finances and investments as a newly single person. "You may not have the same asset allocation as your spouse," said Stein. Decide what's right for you, and make sure your money is invested appropriately.