Retirement accounts, such as 401(k) accounts and IRAs, frequently become sources of contention during a divorce. People often worry about protecting assets that impact their future financial stability, including their retirement savings. Spouses with complex marital estates often need guidance to avoid common missteps, such as improper division procedures that lead to unnecessary income tax exposure and financial penalties.
Couples preparing for divorce in New York are subject to the state’s equitable distribution statute. If they cannot reach a settlement, then they must prepare for litigation and rely on a judge to determine the most appropriate way to split their resources and financial obligations. Typically, any retirement savings accumulated during a marriage are subject to equitable distribution when spouses divorce.
While a 401(k) may be in the name of only one spouse and they may have begun funding the account before getting married, a portion of the account’s balance is likely marital property that they must address when they divorce. Even an employer’s matching contributions can be part of the marital portion of the account.
Spouses and New York family court judges can establish property division arrangements that do not require the division of an account, but splitting a 401(k) is a relatively common in New York divorces. This is especially true if the spouses are still well below retirement age, it is only natural to worry about the income tax consequences and penalties imposed on early withdrawals.
Generally speaking, any funds withdrawn from tax-deferred retirement savings accounts become income for the year in which the withdrawal occurs. Withdrawing a substantial portion of the balance while still working can push an account holder into a much higher tax bracket. Additionally, pre-retirement withdrawals are subject to a 10 percent penalty that can further reduce someone’s anticipated nest egg.
Avoiding the income tax complications and penalties associated with early withdrawals requires the creation of a special document after the courts finalize the divorce. An attorney can draft a qualified domestic relations order (QDRO) that outlines the terms set in the final property division order.
Both spouses must sign the QDRO, and it must be approved by the court. Once all relevant parties have reviewed and approved the document, spouses can then submit it to the financial professional or business managing the account.
A properly-executed QDRO allows for the penalty-free account division that moves a percentage of the original balance into a new account in the name of the other spouse. Following the right procedures can take much of the risk out of equitable property division proceedings during a New York divorce.
Bryan L. Salamone & Associates, P.C. handles complex financial issues for divorcing spouses in Nassau and Suffolk counties. To discuss your particular situation and how New York law applies, you can speak with the Long Island divorce leader by calling 631-388-6009 or contact us online.