401(k) Plans and Divorce
The most common mistakes made when dividing 401k accounts in divorce
It sounds simple enough - you have just agreed that you will receive a portion of your spouse’s 401(k)* account as part of your divorce agreement. You leave the details to your divorce attorney or mediator and move on with your agreement process. Later on, when you hire your QDRO (Qualified Domestic Relations Order) Specialist to prepare your QDRO, you learn that key provisions are missing from your separation agreement and that your benefits may be in jeopardy. This scenario far too common and is a result of underestimating the importance of adding financial expertise DURING the divorce and BEFORE your agreement is finalized. Below are some tips to help you avoid the most common mistakes with 401k division.
Nearly every potential mistake involving 401(k) awards pursuant to a divorce can be avoided if proper attention is given to the separation agreement language. Remember that the agreement language will determine how the QDRO will be worded. The majority of the mistakes that we see stem from insufficient or vague separation agreement language. Even if all parties involved agree on the amount of the award, be sure to take the time to walk through the each of the following provisions and to include language to address each point.
1. Amount of the award – Typically the easy part. Often stated as simple as “Husband awards Wife 40% of his company 401k plan”. Most separation agreement instructions stop here, which can lead to unintended mistakes as the options below are left unaddressed.
2. Valuation Date (Assignment Date) - This is the date upon which the Plan Administrator actually calculates the award. Most often this is simply the date of divorce but in some cases may be an entirely different date. For example, if you separated in March of 2015 but didn’t divorce until July of 2016, it is not uncommon to use March 2015 as your valuation date. A valuation date is important and necessary because it defines the date after which additions and growth are no longer marital or subject to the award. *Negotiating the valuation date is a separate but equally important task.
3. Gains and losses – It is important to understand that it may take several months (longer if you delay the preparation of your QDRO) between the valuation date until the actual date the award is paid out to you. If your agreement language does not affirmatively state that you are entitled to gains and or losses, then your award would not be adjusted. In cases where the stock markets perform well, you could miss out entirely on those gains.
4. 401(k) Loans – In some instances, there may be an existing loan against the 401(k) balance, which means instructions are required to determine if your award will be calculated before or after the loan. Your final award can be much smaller/larger depending on how this is factored. If your agreement does not provide instructions, you are at risk as you will be forced to accept the default option for the plan.
5. Unvested Balances – This is a less common occurrence, however, some 401k matching contributions made by the parent firm will vest over several years, which will impact the total balance available to be split. If this item is not addressed, the recipient may lose out on benefits.
6. Pre-marital Balances – In some divorces, the 401k balance may include contributions made prior to the marriage. It is sometimes agreed that these balances are to be excluded from the calculation and if the separation agreement language is not clear, the final award may be more/less than intended. *If your divorce involves pre-marital balances, be sure to work with an expert to assure the calculation is fair and accurate.
7. Administrative fees – Unfortunately, many plan administrators charge an administrative fee for processing a QDRO (often several hundred dollars). It is best practice to include language as to how this fee will be paid. In some cases, this can be as high as $1,200 dollars.
One last tip as it relates to QDRO preparation and divorce is related to timing. Do NOT wait to prepare your QDRO! We have worked on QDRO cases recently where the parties have been divorced for many, many years and never bothered to have the QDRO drafted. By waiting to draft the QDRO, you put yourself at risk for losing benefits entirely. For example, without a QDRO on file, the following scenarios could occur, each causing disruption to your award:
- The 401(k) owner could withdraw the funds or take a loan against the funds
- The 401(k) owner could change the beneficiary, die and leave you with ZERO benefits
- The 401(k) owner could change jobs and roll out his/her balance to an IRA, which could complicate the calculation and ultimate transfer of benefits to you
- The parent company may switch 401(k) providers, which would eliminate the ability to calculate benefits from a retroactive date and complicate the process
As evidenced by this list, a lot more discussion and thought is required in order to award “40% of the 401k balance”. The items above represent only the most common features to account for when dividing a 401(k) plan and there may be additional items to consider based on the specifics of the plan involved. We strongly recommend that you seek expert divorce financial guidance to be sure your separation agreement language is thorough and that you are well protected. If your attorney is not addressing the items mentined above, seek outside assistance from a divorce financial planner or QDRO Specialist.
Adam Waitkevich is the Founder of Divorce Financial Solutions, LLC. He is a professionally trained divorce mediator and a Certified Financial Planner™ and also hold the Certified Divorce Financial Analyst™ and the Advanced Divorce Financial Analyst™ designations. Since 2010 Divorce Financial Solutions, LLC has helped divorce professionals and their clients make better financial decisions during divorce. DFS provides hourly financial consulting, QDRO strategy and preparation services and post-divorce financial planning solutions.
*For simplicity we use the term “401(K)” to reference any qualified defined contribution plan, which may include 403(b), 457(b) and other types of defined contribution accounts.