March 5, 2015

How to divide retirement accounts in divorce?

Retirement accounts and Michigan divorce

The marital portion (that portion acquired during the marriage) of a retirement account is divided in a Michigan divorce in the same manner as other marital property. However, effectuating the division can be complicated.

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The Basics – How to divide retirement accounts.

The Basics:

 

Retirement accounts come in all shapes and sizes such as an IRA, Keogh, 401(k), 403(b), 457, 409A, pensions, Profit sharing plans, Employee stock ownership plans and others.  The IRS provides a detailed list of the types of retirement plans and here is the link.

 

Michigan divorce property (MCL 552.28 and MCL 552.501) law provides for a division of property acquired during the marriage.  Retirement accounts are property and if the account increased in value during the marriage, the marital portion is subject to division.

 

For Michigan divorce purposes, the various retirement accounts can be classified into two types, a defined contribution plan and defined benefit plan.

 

  • Defined contribution plans are retirement accounts where money is deposited by an employee or employer.  The money can be deposited into a brokerage account, such as a 401(k), or IRA.
  • Defined benefit plans are retirement accounts where the benefit (typically a monthly payment) is defined.  Most pension plans are defined benefit plans and pay a defined benefit.

 

Determining the marital portion can be simple in some cases.  For example, for a simple 401(k) or IRA the marital portion of a retirement account can be determined by subtracting the current value from the value as of the date of marriage. Pension plans, require a more detailed calculation.

 

Some retirement accounts are called “qualified plans” which are governed by ERISA, a federal law governing certain “qualified” retirement accounts. Qualified plans include a 401(k), 403(b), and many pension plans.  In order to divide the qualified plan, a Qualified Domestic Relations Order (QDRO) or (EDRO) must be submitted with the divorce decree.

 

Other retirement accounts are “not qualified“. A non qualified plan includes an IRA and are not eligible for tax deferral benefits under ERISA. These accounts do not require a QDRO / EDRO to divide. These retirement accounts can be cashed in or rolled over in another account.

 

As a general rule an early withdraw from a retirement accounts results in a 10% penalty if you are under the age of 59 ½.  You can avoid a 10% penalty for certain withdraws incident to divorce.

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The Details:

 

 

How to divide a defined contribution retirement accounts in divorce?

Dividing a defined contribution plan is relatively simple. The amount of this retirement account to divide in divorce is determined by obtaining a statement closest to the date of marriage and a statement closest to the date of divorce (or date of separation). The increase is marital property, subject to division. The balance prior to the date of marriage is separate property and not divided upon divorce.

If no contributions were made to a defined contribution plan during the marriage, the passive appreciation is typically separate property and therefore not divided upon divorce.

An Individual Retirement Accounts (IRA) is a type of defined contribution plan that allows you to make tax-deferred investments. There are two types of IRAs a traditional IRA and a Roth IRA. Distributions under a Traditional IRA are taxable and subject to a 10% penalty if you are under the age of 59 ½. Distributions under a Roth IRA are generally not taxable (as they contain after tax dollars) but subject to a 10% penalty if you are under the age of 59 ½.

Individual Retirement Arrangements are typically divided by rolling over the marital portion to a new account. The marital portion is typically ½ of the contributions and earnings from the date of the marriage to the date of the divorce.  To help your lawyer calculate the marital portion he/she requests a balance of the account closest to the date of marriage and a balance closest to the date of divorce.

A  401(k), 403(b), certain annuities and similar defined contribution plans allow an employee to contribute a portion of their pre-tax wages to individual accounts such as a brokerage account. When dividing these retirement accounts in divorce The marital portion of a defined contribution plan is typically ½ of the contributions and earnings from the date of the marriage to the date of the divorce.  The marital portion can be rolled over into a new account or cashed out.  In either case, since if the defined contribution plan is qualified, a Qualified Domestic Relations Order (QDRO) must be entered to divide.

Important notes:

  • When dividing a retirement account in divorce, it is important to distinguish between pre-tax (or tax deferred) accounts and after tax accounts. It is not just to exchange a pre-tax and post-tax account with similar values without “tax effecting” the transaction.
  • Due to market fluctuations and volatility it may also be wise to consider addressing market gains and losses to the date of distribution.
  • The 10% early withdraw penalty can be avoided in certain situations in accordance with IRS publication 504.
  • You can satisfy debt from a retirement account and avoid a 10% penalty by having the non-participant party withdraw cash from a qualified plan (rolled over from the other spouse) and avoid the 10% early withdrawal penalty.  This is authorized under Internal Revenue Code section 72(t)(2)(D).  After taxes, these funds can be used for a multiple of purposes including to satisfy a debt or saved as cash.

How to divide a defined benefit plan retirement account in divorce?

Dividing a defined benefit plan is more complex. A pension plan is the most common defined benefit plan. Unlike a 401(k) or an IRA where your money grows in a bank or brokerage account a defined benefit plan guarantees a certain monthly benefit.  In a defined benefit plan the employer contributes to a plan and pays out a defined benefit upon retirement.

In simple terms if your “pension plan” would pay a monthly payment upon retirement it is a defined benefit plan, if your retirement plan has an account balance without a monthly payment option it is a defined contribution plan. Unfortunately, many people confuse the two types of benefits.

Since a defined benefit plan is a pension plan where the retiree is entitled to collect a defined amount of money every month, the portion earned during the marriage is subject to division in a Michigan divorce. It is quite common for a spouse to be entitled to 50% of the benefit earned during the marriage.

There are three methods for calculating the benefit and they are not equal.

The first method is the prospective coverature method. This method generally produces the largest marital pension benefit.

The second method is the tracking method. This method produces an intermediate marital pension benefit.

The third method is the coverture method. This method generally produces the smallest marital pension benefit and is the most commonly used method for determining the marital portion.

The most commonly used methodology in dividing a pension benefit is the coverture method.  However, the prudent lawyer will identify a methodology that maximizes the position of the client. Therefore, an award of 50% of the marital portion may not be good enough without specifying the methodology.

Dividing a defined benefit plan – the math

Prospective Coverture monthly benefit = (Alternate payee’s awarded % multiplied by the accrued benefit at the date of first commencement multiplied by credited service earned during the marriage) divided by Credited Service at the date the benefits first commence.

Tracking method monthly benefit = (Alternate payee’s awarded %) multiplied by the accrued benefit at division date subtracted by the pre-marital accrued benefit)

Coverture method monthly benefit = Alternate payee’s awarded % multiplied by the (credited service earned during the marriage divided by Credited Service at the division date.)

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The Law – How to divided retirement in divorce

Retirement included in the marital estate. MCL 552.18

MCL 552.18:  Rights or contingent rights in and to vested or unvested benefits or accumulated contributions as part of marital estate subject to award by court; amendment of court order to satisfy requirements of eligible domestic relations order.

Passive Appreciation. Reeves v. Reeves, 226 Mich. App. 490 (1998). Appreciation of Defendant’s minority interest in a shopping plaza during the marriage was “wholly passive” appreciation and therefore not marital property.

Statue of limitations to divide. Joughin v. JoughinMichigan Court of Appeals Docket No. 329993 made an exception to the 10 year statute of limitations rule in circumstances related to qualified retirement plans.  Qualified retirement plans are tax deferred plans like a 401(k) or a pension plan.

Pension. Vander Veen v. Vander Veen, 229 Mich. App. 108 (1998). Value of ex-husband’s pension attributable to the marriage was properly calculated by using “coverture factor,” which is a fraction of years of marriage that ex-husband was working over the total years of his employment, rather than to change in pension’s net worth that occurred during the course of the marriage.

Retirement package. McNamara v. Horner255 Mich. App. 667 (2003), after remand. Husband’s retirement package consisting of a consulting agreement, nondisclosure agreement, non-compete agreement and release agreement was signed prior to the parties’ divorce. The release agreement was properly included as part of the marital estate accrued during course of marriage. The consulting agreement, nondisclosure agreement, and agreement not to compete were excludable from the marital estate as husband’s separate asset in divorce proceeding because they were not earned during course of marriage

Pre-marital accruals. Booth v. Booth, 194 Mich App 284 (1992). Pre-marital accruals are generally separate property, however, a court has broad discretion in awarding premarital accruals if it is just and reasonable (invading separate property pursuant to MCL 552.23(1))

Avoiding the 10% penalty. IRS publication 504.

 

THE BASICS THE DETAILS THE LAW ARTICLES VIDEOS

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Michigan divorce law update. Avoiding a 10% early retirement penalty.

 

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