My client sat in my office in tears. We were talking about dividing the investment accounts she and her husband owned. She was about 40, and he was 44 at the time. Their kids were teenagers. She was a teacher, and he was an engineer. She was very smart but in their division of labor he managed the finances, and she managed the household. I didn’t see any “control” issues. They just had made the decision to divide things between them.
But now they were getting a divorce. She was confused about the ins and outs of their investment accounts. So I decided to give her some basic information about their investments and if you are getting divorced this is information you might need if you were not the money manager. Let me assure you that I have had as many husbands as wives who let the other spouse be the money manager.
There many types of investments, which divided between parties in a divorce case.
There are many types of investments, which are subject to division in a divorce case. The most familiar ones are stocks, bonds, money markets, CD’s, and savings accounts. In addition, many couples invest their money in mutual funds.
A mutual fund is a company that pools money from many investors into a fund. The mutual fund invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments depending on the objectives of the mutual fund. https://www.sec.gov/investor/pubs/inwsmf.htm. A family of funds is a group of mutual funds, which have a common administrative system. Some well-known examples of mutual funds families are Fidelity, Oppenheimer and Vanguard.
The unit of ownership in a mutual fund is the “share.” A mutual fund can issue different classes of shares. Each mutual fund share represents an investor’s proportionate ownership of the fund’s investments, which are collective known as its portfolio. Id. A mutual fund investor is entitled to receive investment earnings on a per share basis. Investment earnings might include dividends, interest or capital gains distributions resulting from the sale of investments in the fund’s portfolio.
For example, a mutual fund may own stock in a company, which is known to have a history of consisting declaring dividends to its shareholders. Because the mutual fund is a shareholder, it will receive dividends from the company. The mutual fund company, in turn, will distribute those dividends on a per share basis to its investors.
How an account invested in one or more mutual funds is divided depends on whether the account is a regular investment account or a retirement account.
If you and your spouse jointly own an investment account, then your mutual fund advisor or brokerage firm will probably have instructions for dividing the account and creating new accounts. The division of an account in joint ownership or even in the name of only one spouse is not taxable under federal law when the division is part of the property division in a divorce.
If the account is a retirement account, then how it is divided will depend on the type of retirement account.
I am going to limit this discussion about dividing retirement accounts to 401(k) and similar retirement accounts, which grow based on how much you and employer contribute. This discussion does not apply to a pension, which is a different type of employment benefit.
A defined contribution plan usually provides an individual account for each participant (the employee) unless the plan calls for pooling all of the employee and employee contributions in one account.
In simple terms, a defined contribution plan provides an employee with a tax-deferred savings or investment account. The balance in the account may fluctuate depending on the type of investments held in the account. The 401(k) plan is the most common type of defined contribution plan.
How an employee can “grow” a defined contribution plan account depend on the employee’s contribution to his/her account unless the employer makes contributions equal to a certain percent of the employees contributions. Under some union plans, only the employer makes the contributions on behalf of the members of the union.
To divide an account maintained by a Qualified Plan requires a Qualified Domestic Relations Orders.
A Qualified Plan is one which meets the requirement of the IRS Code section 414(p) and section 206(d) (3) the Employee Retirement Income Security Act of 1974 (‘”ERISA”). A special order called a Qualified Domestic Relations Order (“QDRO”) is required to divide a Qualified Plan account.
When a QDRO divides a Qualified Plan account, the QDRO typically states that the non-employee (known as the Alternate Payee) will receive a percentage of all of the investments in the account. This type of division ensures that both parties receive a fair share of all of the investments. Otherwise, one party might get all of the cash while the other party might be left with no cash.
It is also common for the QDRO to state that the Alternate Payee’s award will be adjusted for losses and gains on the award from a date certain through the date the investments are moved to the a separate account for the Alternate Payee.
There are several things options for the non-employee spouse to consider when receiving a share of the employee spouse’s retirement.
If you are receiving a share of your spouse’s retirement account, you might be able to leave your money in the employer’s plan. Otherwise, you can move it to a “roll-over IRA” to protect the tax-deferred status of the account. The IRS also lets the Alternate Payee make a one-time withdrawal from a Qualified Plan at the time the Alternate Payee receives the distribution under the QDRO – with no early withdrawal penalty – which the IRS imposes on withdrawals made by people who are not 59.5 years old.
One other option to consider is to “annuitize” the money you are receiving. Wen you annuitize an IRS, you turn a lump sum award into an income stream, which you will receive over your lifetime. You will pay income tax on the money when you receive it. But you will not pay a penalty even though you are not going to be taking all of the money out in a lump sum. Annuitizing an IRA is complicated so you should talk to your lawyer about how the process works.
Finally, you don’t need a court order to divide an IRA or similar account because an IRA is not considered to be a “Qualified” account. Each brokerage or investment firm has its forms to fill out to divide an IRS account in a divorce so check with your lawyer if you are dividing an IRA.
Posted in: Divorce