401(k) Tips

How to Protect Your 401(k) in a Divorce?

Going through a divorce is tough. However, protecting your 401(k) and other retirement assets can help ease the burden and keep your retirement savings on track.

4 min read

Going through a divorce takes its toll on everyone involved. Spouses, children, and family members all bear the brunt of the stress and pain. If you have children, custody is most likely the most significant point of conflict. However, financial mediation can be tenuous as well. If you’ve been married for a while, your retirement accounts—mainly your 401(k)—are your largest marital asset. Fortunately, there are ways to protect your 401(k) in a divorce.

While it’s illegal to hide your 401(k) from your spouse during a divorce, you can protect the assets you contributed before your marriage by documenting the demarcation of your contributions. Additionally, 401(k) distributions due to a divorce are protected from IRS tax penalties by a court-issued qualified domestic relations order (QDRO).

A divorce is a stressful process. The thought of draining your hard-earned retirement funds makes it all the more painful. Unfortunately, there isn’t much you can do with rightfully claimed marital assets. However, knowing your rights and what you can do to keep as much of your 401(k) as possible in a divorce can help ease the burden.

How are 401(k)s typically divided in a divorce?

Contributions made during a marriage on considered marital property. Unless there is a prenuptial agreement that addresses financial assets or 401(k)s in particular, a 401(k) will be subject to division in a divorce.

401(k)s are not always automatically split 50/50 between spouses. Most states follow equitable distribution laws where marital property is divided equitably but not always equally. A smaller number of states follow community property laws and divide all marital assets 50/50 in a divorce. It’s essential to understand your state’s laws regarding 401(k)s in a divorce. Your attorney will have up-to-date knowledge of what rules apply to your situation.

This only applies to the marital asset portion of the 401(k). Contributions made prior to the marriage are not required to be split in a divorce, given they are properly documented.

For instance, if you contributed $20,000 prior to getting married and $80,000 while you were married, you’ll have contributed $100,000 to your 401(k) in total. However, only $80,000 will be subject to division in a divorce. Additionally, the corresponding percentage of the growth of your 401(k) will be split.

This is important to remember in order to protect the portion of your 401(k) that is rightfully yours.

Know your plan’s rules and guidelines.

Because of specific tax laws and regulations governing 401(k) plans, divvying them up in a divorce is different from other types of assets like houses and savings accounts.

Your 401(k) summary plan description will outline the details of how your 401(k) will be divided in a divorce.

Your human resource department or 401(k) plan administrator will be able to supply a copy. This will be needed when working out the details of the divorce.

Protecting your 401(k) in a divorce.

Unfortunately, if your soon-to-be ex-spouse has a right to the funds in your 401(k) and demands them in the divorce, there isn’t much you can do. You can negotiate your 401(k) with other assets. However, many states give access to 401(k)s funds contributed during the marriage to both spouses.

You can protect the contributions you made prior to getting married as your ex-spouse doesn’t have rights to that portion of your 401(k). The mistake many people make in a divorce is assuming the entire 401(k) balance is subject to being split. It’s essential to note the balance when you got married in contrast to the balance at the time of the divorce.

Obtaining copies of past statements can help your attorney decipher what portion of your 401(k) is classified as marital assets.

What are the taxes on 401(k) distributions in a divorce?

Protecting your 401(k) from taxes and fees is vital to keeping your retirement savings on track. 

Typically, distributions made prior to turning 59½ are subject to income tax and a 10% penalty tax by the IRS. However, distributions from a 401(k) in a divorce are exempt from the 10% penalty tax.

A court-issued qualified domestic relations order (QDRO) will be necessary to prove the distributions you made from your 401(k) were because of a divorce.

Making sure you file the necessary paperwork correctly will prevent problems down the road. Your divorce attorney will be able to assist in ensuring this is done correctly.

Additionally, spouses that choose to rollover the proceeds from a divorce to an eligible retirement plan will not incur any penalties or income tax obligation. So long as the funds are deposited into such retirement account within 60 days of distribution.

What is a divorce cash out?

Often, an ex-spouse needs the funds from a 401(k) to put a down payment on a home or fund their transition to life on their own.

Funds cashed out of a 401(k) as part of a divorce settlement are not required to pay the additional 10% penalty tax. However, these distributions will still be subject to regular income tax.

Spouses are designated beneficiaries, even ex-spouses.

When joining a 401(k) through your employer, you’re asked to designate a beneficiary. A beneficiary is someone who has legal access to your 401(k) when you pass away. Most 401(k) participants don’t end up assigning someone as their beneficiary.

By default, spouses are designated as a 401(k) plan beneficiary. In order to assign someone else as a beneficiary, the spouse needs to approve of such changes.

Surprisingly, this designation stays with that spouse even after a divorce. In order to assign a new beneficiary—even a new spouse—post-marriage, the ex-spouse will need to sign away their right from being the beneficiary.

To protect your 401(k) from your ex-spouse becoming beneficiary after a divorce, it’s important to have them sign away their beneficiary rights during the divorce proceedings. This will prevent you from having to go back months or years later to have them sign away their rights.

Use this information with your attorney.

Even with this information, it’s essential to consult your divorce attorney when dealing with splitting your 401(k) in a divorce. Do your due diligence and gather the necessary documentation. This will help them navigate the divorce proceedings and better protect your 401(k).

Additionally, hiring the advice of a certified financial advisor who specializes in divorces can help you best manage your 401(k) during a divorce. Knowing the tax implications and how to minimize the damage can help you protect your 401(k) more.

Divorce is never easy. Even cordial separations come with their difficulty. Finances tend to be the number one issue most have when going through a divorce. However, knowing how to protect yourself and your 401(k), you can ensure your long-term retirement goals stay intact.