Many people involved in divorce, and often their attorneys, think that dividing a 401k in a divorce is a simple matter. Not understanding the nuances of 401k plans can lead to an unfair outcome for the parties and potential malpractice for an attorney.
When parties divorce, the South Carolina law requires a division of all property acquired during the marriage regardless of how it is titled. A 401k is property and must be divided, regardless of how titled, as long as it was acquired during the marriage.
A 401k is an employer sponsored retirement account. The IRS requires that when dividing a 401k in a divorce action, a separate court order, or Qualified Domestic Relations Order (QDRO), must be used to avoid tax consequences to the spouse receiving the money. Two common issues will often arise when considering the division of a 401k:
- What portion of the 401k balance should be divided.
- How should the 401k be divided?
First, when a 401k is acquired prior to the marriage and deposits continue after the marriage, at the time of divorce only the marital portion is subject to division by the QDRO. For example, if Wife had $25,000 in her 401k at the time of marriage and at the time of the filing of divorce she had $100,000, then the marital portion would be $75,000, right? Well, actually NO!
South Carolina law is clear that property acquired prior to the marriage will generally remain separate property, and not part of the marital estate. Wife’s 401k balance at the time of marriage will continue to accrue interest during the marriage, and all of this interest will also be her separate property.
If Wife was married for 10 years, and was conservatively earning 5% on her 401k, at the time of divorce she will have earned $15,722 in interest! A sloppy lawyer will simply give this money away if he divides Wife’s 401k 25-75.
Second, it is important to remember that a 401k is almost always a mutual fund. When we are in the process of dividing a 401k in a divorce case, we must make sure that language is included in the QDRO that specifies
- that the allocation of benefits be on a pro-rata basis from all accounts
- that the benefits assigned will not include outstanding loan balances taken by the participant, and
- investment earning will be applied from the date of the filing of the divorce action until the date of distribution.
What appears to be a relatively simple matter, dividing a 401k, turns out to be not so simple! QDRO’s need to be drafted skillfully and with attention to all of the nuances involved in the divorce.