Retirement accounts are a common point of contention in many divorce cases. Like all other property, retirement accounts must be characterized as community property or separate property, and then divided. However, special rules govern how the retirement accounts are dealt with, which can complicate a divorce if the appropriate steps aren't taken. While the rules related to dividing retirement accounts may seem needlessly complex, they are quite straightforward.
Any community property funds deposited into a retirement account are community property, and stay community property. As such, the other spouse can be entitled to some of the value of the retirement account. Sometimes retirement accounts consist of both community property and separate property funds. When this happens, dividing the community property portion of the retirement account can become more complex.
This usually occurs in one of two scenarios: First, a spouse may have a retirement account from before marriage but continued to deposit funds into the retirement account during marriage. Second, a spouse may have first opened a retirement account after the date of marriage, but continued making deposits into that retirement account after the date of separation.
In either case, the court will apply the same rule — called the time rule — which looks to how long the retirement account existed compared to the length of the marriage, and when the contributions were made. Funds from community property put into the retirement account are still community property. The other spouse, whose name isn’t on the retirement account, has a community property interest in any funds contributed to the retirement account after the date of marriage, but before the date of separation. However, that other spouse has no community property interest in any funds contributed to the retirement either before the date of marriage, or after the date of separation. Once the community property portion of the retirement is known, each spouse is entitled to one-half of that portion.
Example: Jane’s Retirement account
Let’s discuss and example: Suppose Jane opens an IRA on January 1, 2012, and makes payments to the account with her salary from work. Suppose on January 1, 2014, Jane marries John. Suppose Jane and John separate on January 1, 2016, and Jane files papers to divorce John. Lastly, suppose Jane continued to deposit a portion of her salary into the IRA throughout and after the marriage, but closed the IRA and withdrew everything on December 31, 2016. What portion would John be entitled to upon divorce?
Jane and John were not married for the first two years, or the final year, of the IRA’s existence. The remaining time, they were married. The income Jane earned, and then deposited into the IRA account, was community property. John is therefore entitled to half of what Jane deposited into the IRA during that period. Jane is entitled to the other half of the community property portion of the IRA account, as well as the entirety of what remains as her separate property.
In this example, Jane’s IRA was open for five years. Jane and John were married for two years. So, John is entitled to half of the funds deposited during those two years, or a one-fifth share of the value of the IRA, as his community property. Jane is entitled to the other one-fifth share as her community property. Jane is also entitled to the remaining three-fifths of the IRA because those deposits were made either before the date of marriage or after the date of separation, and are therefore her separate property.
Dividing Retirement Accounts in a California Divorce
Once the actual value in a retirement account has been determined, it still needs to be divided. Although the retirement account contributions can consist of community property, the retirement account itself is in one of the spouses’ names. There are three basic ways retirement accounts can be divided in a divorce.
1. The QDRO
The first way to divide retirement accounts is with a Qualified Domestic Relations Order, or a QDRO. A QDRO is a court order authorizing the company holding the retirement account – the account custodian – to create a new account for the other spouse. The account custodian then deposits the other spouse’s share of the original retirement account into the new account created for the other spouse. The actual terms and language of a QDRO will vary depending on the account custodian holding the account, the type of account, and the specific split the custodian will be making. The divorce must be final and a judgment entered before the Court will issue a QDRO. Getting a QDRO will typically one of the last documents prepared in a case.
2. The buy-out
Once the value in any retirement accounts is determined, another way to divide the retirement accounts in a divorce is to leave the retirement account alone, and allocate an amount of community property to the other spouse equal to what he or she would have received from the retirement account. This method avoids the procedural and technical difficulties in dividing a retirement, while still ensuring an equitable division of property. However, sometimes there are not enough assets in the marital community to equitably offset the retirement. Most couples’ largest assets are their home and then their retirement accounts. If one spouse keeps the retirement accounts in that spouse’s name, there might not be sufficient assets to “balance” the community property division for the other spouse.
Additionally, the parties both must agree to the buyout option. In heavily-contested divorce cases, the spouses might not agree, so it might be easier to just request the retirement accounts be divided by QDRO. In uncontested divorces, however, the buyout is a common method of dividing retirement accounts.
Buy-outs require careful analysis because retirement accounts are tax deferred, which means that no tax has been paid on the balance of the retirement account or the income earned by the funds in the retirement account. So, for example, one spouse’s $50,000 community share in retirement funds might not necessarily result in a $50,000 payment to equalize the property division, because of the tax issue. Tread carefully, and consult with an attorney.
3. You take yours, I’ll take mine
Technically, this isn’t an actual method of division, but it’s a common-enough arrangement that it bears mentioning. As the name suggest, this method involves each spouse retaining the retirement accounts in his or her name. This can include an equalizing payment by one spouse to the other to make sure that the community property is divided equally. However, sometimes divorcing spouses will agree to not require an equalizing payment. While each party taking their own accounts can lead to some less-equal property divisions, it also avoids most of the above procedures. It’s simple, it’s intuitive, it’s cheap, and it happens all the time. If you and your spouse both understand the trade-offs and agree, this method for dividing retirements is perfectly fine.