Funding a 401(k) is a common way for working professionals to put money aside for retirement. People can reduce their taxable income and set aside money that can help them cover basic expenses when they stop working full-time. In some cases, employers may even make matching contributions to 401(k) accounts. They offer a host of benefits for those thinking about their long-term financial stability.
Married couples who decide to divorce may face a variety of challenging financial decisions during that process. They have to negotiate terms for splitting up their property, including their financial resources. 401(k)s can be a challenge to effectively address during divorce negotiations.
What are some of the possible solutions for handling a 401(k) during a divorce?
Dividing the account
In cases where only one spouse has a 401(k), the most appropriate solution might be to divide the account. Each spouse can retain a portion of the total balance. Unfortunately, making an early withdrawal before reaching retirement age can result in a 10% penalty and an increase in income tax obligations. Spouses may need to cooperate to draft and record a qualified domestic relations order (QDRO) to avoid penalties and tax consequences when splitting their accounts.
Retaining personal accounts
It is relatively common for each spouse to have a 401(k) account in their name. The spouses might agree to retain their individual accounts. They can then make other property division choices based on any difference in value between the two accounts.
Offsetting the account’s value
In cases where there is only one 401(k) account or where the spouses have funded accounts with significantly different financial values, they may need to get creative to create an equitable or fair property division settlement. Home equity, bank accounts, personal property and even vehicles can help balance out the value of a 401(k) retained by one spouse.
It is also sometimes possible to use marital debts as a means of offsetting the value of a 401(k) during property division negotiations. If spouses can reach an agreement about how to fairly divide their property, then they don’t need to litigate. They can pursue an uncontested divorce.
Exploring different solutions for fairly addressing high-value resources, including retirement savings accounts, can help people avoid divorce litigation. Spouses who approach divorce carefully can work to preserve the resources that they need for stability later in life.