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Divorce Strategies Group

Denise French

Dividing Property

Common Ways to Hide Assets in Divorce

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Have you ever wondered if the opposing party in a divorce case has actually disclosed all the assets of an estate?  Do you feel like your spouse might hide assets in divorce?  

Common Ways to Hide Assets in Divorce

This article covers creative ways people have hidden assets in divorce and conversely, ways we have found those assets.  We feel like the best way to talk through a divorce is with integrity and dignity without lying about assets.  Often, doing so could backfire on you.  However, if you feel your spouse is lying about money, here are a few places to look.

Excess ATM Cash Withdrawals

Excess cash withdrawals from ATM’s are fairly common.  One spouse will start taking small withdrawals on a regular basis from ATM machines.  Instead of using the cash for legitimate purposes, they stockpile it and forget to mention this as an asset when walking through the estate valuation.  They claim they have spent all the money and have no cash on hand when in reality they have a lot of cash on hand.   We often are able to track exactly how much cash was spent, on average, in normal conditions and then compare that to the months leading up to the divorce and in the divorce months.

Stealing Hard Assets

Some people will literally “hide” assets.   For example, imagine if a couple has a lot of jewelry that’s been accumulated over the years from various sources. Prior to inventorying, one party takes a few select items from the jewelry box and hopes the other party doesn’t notice anything is missing.

This can also be in the form of hiding items in safety deposit boxes whether they be straight issue bonds in coupon form, stocks in issue form.

hide assets in divorce

Another form of stealing cash is having cosmetic surgery or taking an expensive lavish trip soon before requesting the divorce.

Overpaying Debt Instruments & the IRS

One way to having a cushy safety net is by overpaying the IRS.  An unethical spouse can change their W2 withholdings if you are employed by a firm.  Doing this creates an account you know will be refunded when you do your taxes the next year and it lowers your spendable income today for purposes of child support and negotiation.   If you are self-employed your ability to overpay the IRS can be in the form of quarterly payments from company distributions or again, increasing your W2 withholdings if you pay yourself.

If a credit card is overpaid and the credit balance sits for a while, the credit card company will refund the overpayment, usually in the form of a check. The party that overpaid the credit card can then take that check and cash it. To the other party, particularly those who aren’t close to the household finances, it just looks like credit card debt was paid.

hide asset in divorce

Self-Employed Financial Games

Self-employed parties have many ways to attempt to hide income and assets in their business. Income can be hidden by increasing expenses or by paying a large expense that must be done but wasn’t budgeting for a few more years. For example, buying a huge piece of equipment you had originally planned to buy in a few years will lower your income which could lower the value of your business.

Self-employed people can overpay taxes with increases to their W2’s or increase their quarterly payments to the IRS.  Self-employed people can also delay being paid and sit on a large amount of account receivable until after the divorce.

In Texas and many other states, personal goodwill is not a community asset. Games can be played here to try to increase personal interest and personal involvement in business as to decrease the value of the business in the community estate.

If you are considering divorce, it’s important that you have the right professionals involved. A Master Analyst in Financial Forensics ® (MAFF®) and a Certified Divorce Financial Analyst® (CDFA®) has the training to help uncover shady acts like the ones listed above. And here at Divorce Strategies Group, we have both the hearts and minds to help make sure your financial outcomes in divorce leave you feeling confident. It’s all about having the right people on your team. If you are concerned your partner will hide assets in divorce or need some professional divorce help contact us today.

An Alternative for the Small Business Owner

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[three_fourth_last]Unique challenges that other, regular W2 employees don’t have plague small business owners and divorce. A business owner’s divorce attorney (or their spouse’s divorce attorney) will often ask that a business valuation be completed. Not only is this another time-consuming item on the divorce check-list, but it’s an expense typically ranging between $7,500 – $20,000. The appraisal may take weeks if not months to complete and much information will be requested of the owner. This can be overwhelming to the business owner who is already exhausted due to the time, emotion and costs of the divorce itself.

Small Business Owners and Divorce

There is an alternative to the comprehensive business valuation report which can help the small businessperson save both time and money while providing the attorney with a reliable, third party number to use in mediation. This is the Calculation of Value Report. According to the National Association of Certified Valuation Analysts (NACVA), a Calculation Engagement occurs when the client and member agree to specific valuation approaches, methods, and the extent of selected procedures and results in a Calculated Value.

calculation of value report

What will a Calculation of Value Report include?

The calculation report will perform a deep dive into the financials of the company as any business valuation should. The report will be short, typically 6 – 8 pages and if conducted according to the standards of the NACVA it will include the purpose of the report, description, ownership size, nature, restrictions and agreements of the interest being valued as well as a calculation date and report date. It will include the scope of work, calculation procedures, hypothetical conditions/assumptions and the reason for their inclusion. It will include subsequent events which are considered and denote if reliance on a specialist was required. It will include a statement of the financial interest and whether or not the author is obligated to update the report. Finally, it will be signed by the valuation analyst who is responsible for providing the report.

The calculation report should show normalized financial schedules for the subject company. The owner’s compensation, as well as other balance sheet and income statement non-recurring items, should be reviewed, researched and normalized. The company documents including financials, tax returns, corporate documents, buy-sell agreements and other articles of incorporation should be reviewed. An interview with the owner will still need to be conducted, although they are usually done remotely via a zoom meeting or facetime on a smart-phone. The calculation report will also include any discounts for lack of control if the owner is not the sole owner and discounts possibly for lack of liquidity.

Typically, two of the three approaches will be used whether it is the Asset Approach usually using the Adjusted Net Assets Method, the Income Approach using either the Capitalization of Earnings or the Discounted Cash Flow Method and/or the Market Approach typically using the Guideline Public Company Method showing both the Seller’s Discretionary Earnings Multiple and the Revenue Multiple. The financial schedules showing the numbers will be included in the report as well as a list of the sources of information utilized to derive the calculated value.

calculation of value report

When would the Calculation of Value Report be appropriate?

These reports are often used in mediation. They provide a way to save time and expense as they are produced in a shorter time period and cost less than a full conclusion of value report. We offer these reports for a flat rate between $3,500 – $5,000. A word of caution, these reports may not be accepted by the courts but can be morphed into a full report if court becomes a necessity.

Overall, this is a way to save time and expense while providing a calculated value of the subject company based off its historic, current and expected financials.

Small Business Owners and Divorce Services

Please look around our website and blog pages at www.DivorceStrategiesGroup.com for helpful information regarding small business owners and divorce finance or to schedule a consultation to discuss how we can help you with the financials of your divorce.

Should You Keep Your House in a Divorce?

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The marital home is almost always a hot topic of debate in divorce situations. If you have concerns over your marital home in divorce, you are not alone. Not only do you have the financial issues to deal with, there are often sentimental attachments to the home. The home is where you raised your family, created memories and have comfort. You’re possibly worried about moving your children or making them switch schools if you sell the home. You may also have close relationships with your neighbors or other strong ties to the community.

Even if you are not particularly sentimental, you may not want to think about moving in the midst of all the other changes happening in your life. Moving is at the list of top 10 stressful things you can do – why add that to the divorce stress? Not only that, the interest rate on the home is so low, you don’t want to give that up.

However, you have to look at the overall financial picture and make the best decision for the long term. Keeping a house when you cannot afford it is one of the most common financial mistakes that people make when going through a divorce. Keeping the house in lieu of other assets which will grow faster and better may also not be the best decision. This is a tough decision and hopefully we can help you find viable answers. Here are 5 steps to follow to determine if keeping your home is in your best interest or not.

 

keep the house in divorce

Step 1: Determine the value of your home.

This is a vital step. You must know how much your home is worth in order to make an informed decision. This can be accomplished in several different ways. The most solid option is to have the home appraised by an independent, third party appraiser both spouses agree to use. That is the most accurate and will provide a solid number. It will cost anywhere from $300 – $600. It may be well worth it for the peace of mind this solid number will give you.

If that is not an option or you don’t want to spend the money, ask a realtor to run comparisons on the house (referred to as “comps”). These are done for free usually. Ask the realtor to run comps on homes in your area which have sold with similar square footage and upgrades. You probably know your neighbors and have been in their homes. Ask for houses that you know are similar to yours as far as upgrades to the kitchen, bathrooms, flooring or a pool. The comps report will have several homes and this will help you determine which most closely mirrors the value of your home.  You could also simply average the home comps values to determine the value of your home.

Another option is to look online in your county to see your tax appraised number. To do this visit the county in which you reside and search for your home or your street. Your name should come up if you dig around on the site for a bit. Some counties will have a tax valued number and a market valued number listed on their valuations. If so, we typically use the market valued number.

Lastly, you can run a Zillow report on your home. This is the least accurate, but at least is another point of information for you to use. To do this visit www.zillow.com and simply input your address. The Zillow numbers, we have found, are usually low.

With one or multiple of those 4 options, you now have a more informed number to value your home with.  Once you know the value of the home, you can determine how much equity is in the home. Take the value of the home and subtract any loans on it. This gives you the net equity value of your home.  If there are no loans, the value and the equity are equal.

 

keep the house in divorce

Step 2: Determine the annual cost of home ownership.

The cost to keep the home is not just the mortgage and taxes, it’s so much more. How much does it cost for all the other monthly expenses and upkeep? Is the house large and has a big electric bill? What’s the difference in the home cost in January versus July? We suggest looking at each season and putting the cost of the home on a spreadsheet then averaging it out monthly. It’s not fun to do but grab a glass of your favorite beverage and get to it. This exercise can pay you handsomely in the future.

The following is a list of costs to consider regarding monthly costs: electricity, gas, water, trash, HOA, lawn care, pool care, home warranty, cleaning/maid service, seasonal costs of mulch, fertilization, deep cleaning, pool filter cleaning or chimney cleaning.

The following is a list of other items to consider: roof needs, condition of AC and water heaters(s), age of house and general repair needed on going, condition and maintenance of major appliances, past flooding issues and any other current needs you know of which need repair.

We encourage everyone to have an inspection completed on the house if you are leaning toward keeping it so that if you have issues, you can add the cost of repair to them into divorce negotiations. What if you have unknown foundation issues or termites? What if your roof needs repair and you didn’t know? Or, what if you have rodents in your attic, bees in your brick overhand or birds in a crawl space which are all issues I have personally dealt with and they cost money to fix.

You want to include the cost of repair to those in the divorce negotiations instead of finding out about them after the settlement is complete.  We often consult with Check It Out Home Inspections for this as they do good work and are thorough.

Schedule a cost of living planning meeting

keep the house in divorce

Step 3: Review the house within the overall context of your estate.

I often find couples are trying to figure out the finances themselves and they want to divide each piece of property or account separately. Doing this can skew the overall estate significantly toward one spouse and leave out vital details. You also lose the ability to build creative win-win settlements by doing this. We place the entire estate on a spreadsheet to value and view the overall picture. You also need to know the cost basis of each asset and resulting tax ramification of each asset. This will allow you to see how much of your estate you are truly retaining in the divorce.

The house is part of the estate as are the values of your bank accounts, brokerage accounts, retirement accounts, stock accounts, employee benefits, car values and debts. Not only are the values needed, but the net tax value is needed. Everything goes on a spreadsheet and is assigned a value. After you do this, you have a view of the estate. This enables you to make better decisions regarding what to keep and what to give up.

If you find the house is one of the largest assets in your estate and you are negotiating to keep it, you are likely going to be giving up other assets. What are you willing to give up in exchange for the house?

What is the long-term ramification of the decisions you are making? Is your net worth going to grow more with the house in your estate or the stock account? Are you going to be better off month to month with this home or with a smaller home in the same area and that bank account to use?  If you find the house has a lot of debt and not much value, then why fight over it?

Schedule a review of your proposed settlement

keep the house in divorce

Step 4: Consider creative settlement options.

If you decide to keep the house, you could choose to offset the house with other assets. For example, let’s say you are dividing the estate 50/50. Your house is valued at $350,000. There is also an investment account that is valued at $350,000. You might give up the investment account so that you can keep the house.

If you do not have other assets to offset the value of the home or you do not want to offset the value of the home with other assets, you might choose to get a loan to pay your ex out on his/her portion of the equity. If you are considering a loan, take extra care not to negatively impact your credit score during your divorce.

If there’s still a mortgage on the house, sometimes it can be a little more difficult to keep the house in a divorce. Ideally, you will refinance it in your name so that your ex is no longer responsible for the debt. Typically, you’ll have to walk through the refinance process and have the home on your own credit. If you are a non-working spouse, you can sometimes use child support or spousal support as income. There are rules and guidelines to this, so you’ll want to check with a lender now in order to plan for the near future.

Depending on how much equity is in the home, you might be able to refinance enough to pay your ex out on his/her portion of the equity. Let’s use the same example as before. Your home is worth $350,000 but you have a $150,000 mortgage on it. Thus, there is $200,000 in equity in the house. You will need $100,000 to buy out your spouse’s share, if you’ve agreed to a 50-50 split. To get the money, you refinance into a $250,000 loan in your name only, and cash out $100,000 to pay your spouse. (We are excluding the transaction costs to keep the example simple.)

If you prefer not to refinance for the higher amount, you could negotiate offsetting the equity with other assets you are dividing.

keep the house in divorce

Step 5: Important steps to take after a decision is made.

No matter what option you choose, you’ll likely need some legal documents to make this official. Be sure to consult with an attorney on what deeds need to be created and signed. No matter if you are keeping the house or giving the house to your ex-spouse, you’ll need to complete some paperwork.

A Deed to change ownership will be needed and we encourage the spouse leaving the house, if there is a mortgage, to have a different deed for protection. Consult with an attorney to determine what is needed to protect your newly acquired asset and/or your credit.

No one (or court) can force a lender to assume the mortgage in just one person’s name where two currently exist. If the underwriting process is not an option to remove a spouse from the mortgage, there are other items of protection and possibly other negotiations to do in order to provide the spouse losing the asset but retaining the debt with an equitable offset.
You’ll also need to remove your ex-spouse from the insurance policy on the home and you’ll need to talk to your insurance company about this. We also recommend running price checks on the cost of the insurance at this point to see if you can get a lower rate. For a complimentary, multiple company rate quote visit Sig F&M Insurance Group.

The Big Picture…

Remember that deciding if you should keep the house in divorce is not a purely emotional decision. Make sure that it fits within your overall financial goals. If you are not sure if you can afford to keep the house, contact us. We can work with you to create a broader financial plan to determine if it makes financial sense. Contact Divorce Strategies Group for a divorce financial planning meeting today.

The 401(k) Plan and Your Divorce

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Divorce itself is an emotionally charged, troubling process. When you add major financial decisions to the mix it can create a recipe for disaster. Our goal is to help litigants make sense of the financial maze they face in divorce and navigate the process with confidence.

401(k) and Divorce

A large portion of many divorce settlements we are hired to help with involve retirement plans. Per the Investment Company Institute, as of December 31, 2018, 401(k) plans held an estimated $5.2 trillion in assets and represented 19 percent of the $27.1 trillion in US retirement assets, which includes employer-sponsored retirement plans (both defined benefit (DB) and defined contribution (DC) plans with private- and public-sector employers), individual retirement accounts (IRAs), and annuities. In comparison, 401(k) assets were $3.1 trillion and represented 17 percent of the US retirement market in 2010.

The 401(k) and Divorce, Explained

It’s no surprise that retirement plans hold a large portion of discussions in divorce cases. Because this specific retirement plan is such a large part of so many divorces, we want to help the reader understand the composition of the 401(k), taxation of the 401(k), and the pros and cons of keeping or receiving this asset in divorce. There are three parts which comprise a 401(k) plan. Those parts are (a) employee deferrals, (b) employer matching contributions and (c) employer elective contributions or profit sharing.

Employee Contributions or Deferrals

This is the employee’s contribution into their own retirement plan and is 100% vested immediately. You keep your elective employee contributions no matter how long you have been with your employer. Taxation of your contributions depends on how you chose to contribute them. Here are four ways an employee can contribute to their 401(k) for tax purposes.

1) Elective, Pre-Tax Deferral Contributions
These are also called salary reduction contributions and are the most common types of contributions to retirement plans. You elect to have money deducted from your salary each pay period and contributed to your retirement account. Pre-tax dollars are contributed, which means that the money does not have any tax withheld from it before it is put in the retirement account. This can be a percentage of your pay or a set dollar amount each month. Money that is contributed in this way is not reported as taxable income. This helps decrease your taxation the year of contribution and your assets grow tax deferred. You are taxed on these assets when they are distributed as ordinary income.

2) Designated Roth Contributions
A designated Roth contribution is similar to an elective deferral, except the amount deferred is taxable as normal income prior to being contributed into the 401(k). You can again pay a set percentage of your salary or choose a set amount to defer each month. Your assets will grow tax deferred and this portion of the deferrals are tax free when distributed. There is just no tax benefit in the year of contribution.

3) After-Tax Contributions
Not all retirement plans allow after-tax contributions. These are generally non-Roth contributions that you choose to make in addition to your regular elective deferrals of salary. If your plan allows after-tax contributions, any contributions that you make must be included in your taxable income. After-tax contributions may not be deducted. We see this with highly compensated employees who wish to maximize their deferral limits up to the IRS allowable maximum each year. The contributions grow tax deferred. Earnings are taxed when distributed as ordinary income.

4) Catch-up Contributions
If you are at least age 50 by the end of the year, you may be able to make additional, nontaxable, elective deferrals beyond the basic limit on contributions. If your plan allows it and you qualify, you can make these contributions, up to the catch-up contribution limit, even if you have made regular deferrals up to the regular limit. Catch-up contributions are a good option for those who perhaps did not contribute a lot to their plans in the past, for those who waited until later in life to start saving for retirement, and for those who just want to ensure a comfortable retirement.

employer contributions

Employer Contributions

1) Matching Contribution
The second portion of the 401(k) is the employer matching contributions. This amount is also 100% vested no matter how quickly you leave your employer after receiving the contributions.
In most retirement plans, your employer can make contributions to your account on your behalf. In some plans, employer contributions are mandatory; in other plans, they are discretionary (optional).

Elective deferrals by employers are called matching contributions because the employer matches a certain amount per dollar contributed by the employee. For example, for a plan that is considered “safe harbored” the minimum an employer must match is dollar for dollar up to 3% of your salary deferrals and .50% for the next 1% and an additional .50% for the following 1% you defer of your salary. In this case, if the employee defers 5% of their salary into the 401(k) the employer will contribute 4% of the employee’s salary into the 401(k) for a total of 9% of the employee’s salary annually deferred. The employer can elect to contribute more or less, depending on how the plan is created and current IRS imposed rules. Matching employer contributions are not taxable income to the employee (though the amount may be shown on your W-2.) These funds grow tax deferred but are taxable to the employee when distributed as ordinary income.

2) Discretionary Contributions (Profit Sharing Plan)
Discretionary, or non-elective, employer contributions are the third portion of the 401(k) which are typically referred to as the Profit Sharing Plan portion of the 401(k). These are contributions made in addition to matching contributions, at the employer’s discretion. Such a contribution must be made equally to every employee covered by the plan; it cannot typically be made only to certain individuals. Discretionary contributions by employers are generally nontaxable income for you today, grow tax deferred but are taxed when distributed in the future to you as ordinary income. The Profit Sharing Plan portion typically has a vesting schedule which can either be a three-year cliff vesting or a certain amount of years vested schedule. Three-year cliff vesting means the employee is 0% vested until the 3-year mark of employment. Yearly vesting schedule means you are vested a certain amount each year such as 20% per year for 5 years and you are fully vested after 5 years.

QDRO edit

Qualified Domestic Relations Order (QDRO)

A Qualified Domestic Relations Order (QDRO) is the federally mandated tool utilized to move a 401(k) from one spouse to another spouse as part of a divorce settlement. When moving funds, the recipient spouse can receive the 401(k) funds in one of three ways: (a) cash, (b) another 401(k) or (c) their own Individual Retirement Account (IRA).

Cash

It is quite common that the 401(k) is the largest cash asset in a couple’s estate and one party will need funds to help them after the divorce for the purchase of a new home, living costs or attorney’s fees. It is so common to use these funds in a post-divorce situation; the IRS offers a penalty to break for cash from a 401(k) specifically pursuant to divorce.

If you move funds from a 401(k) to cash you will be taxed on the funds as ordinary income (as if you had a job that earned as much as you are receiving in cash) as well as an additional 10% penalty if you do not meet certain exemptions which include being age 59.5 or older, death, disability, or 72(t) systematic withdrawals or receiving funds via a QDRO.

If you need cash you will be taxed on any non-ROTH 401(k) funds you receive, but you will NOT be penalized the additional 10%. For example, Sue and John divorced. John has $800,000 in his 401(k). Sue received 50% of that asset. Sue needs $200,000 to purchase a home. Sue was advised by her CPA to redeem $250,000 from the 401(k) in cash. $50,000 of that was sent directly to the IRS for taxation and $200,000 was put into Sue’s bank account. The remaining $150,000 was sent to Sue’s own IRA. That $150,000 was not taxed nor penalized. That portion became Sue’s own IRA and was treated as such going forward.

QDRO Funds to a 401(k)

If you move funds from a 401(k) to another 401(k) you will not be taxed or penalized. Some plans will allow you to stay in the current 401(k). We do not typically recommend this as it’s tethering you to your ex-spouse and your old life. You can typically purchase the same investments in your own IRA. Some plans will allow you to roll the funds into your own 401(k). We also typically do not recommend you roll the funds into your own 401(k) because it limits your investment options. If you roll the QDRO funds not your own IRA you have a greater mix of funds to choose from or at the least, a different mix of funds to choose from and you can do it often without the 401(k) administrative fees.

QDRO Funds to an IRA

If you move the QDRO funds into your own IRA it will be done without taxation or penalty. You will create your own Individual Retirement Account and it will be treated as one you created from inception. Your ex-spouse is no longer a part of this; it’s your own account invested as you see fit. If it is in an IRA, you will have no constraints on your investment selection. We advise you consult with an experienced financial advisor to help you invest according to your own goals, time horizon and risk tolerance when determining how to invest any divorce process.

Summary

The 401(k) is a wonderful tool to help build wealth. When you are awarded one or a portion of one in divorce it can help you in a tremendous way either today with cash flow or in the future for our own retirement. We can help you in a variety of ways with the financial portion of your divorce settlement. Call our office for a complimentary consultation to discuss your specific needs, goals and circumstances. Contact us to schedule your personalized meeting.

How Much Divorce Settlement is Enough?

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So, what could have been one of the biggest and messiest divorce stories of the decade has come to a rather quick conclusion. Jeff and MacKenzie Bezos have come to an agreement on their divorce settlement. If you need me to bring you up to speed, a $137 Billion Dollars were at stake. And in a Community Property State! The Bezos’, among other things, built the company Amazon during their marriage, acquired a lofty fortune, and Jeff Bezos acquired a lofty title along the way. The world’s richest man.

The World’s Richest Couple
While I personally thought of them as the world’s richest couple, if the divorce had just gone by the definition of the law, they would each have walked away worth about $69 billion in the divorce settlement, therefore splitting the difference and giving the title back to Microsoft owner, Bill Gates

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Retirement Accounts in Divorce: Five Common Questions

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QRDO edit

Valuing and dividing retirement accounts is more complex than most divorcing couples expect.  Below are common questions we receive regarding retirement accounts and divorce.

1. Can a retirement account be divided without triggering taxes?

A tax-free division is possible, but each plan or account has different requirements.  While the division of marital property generally is governed by state domestic relations law, any assignments of qualified retirement interests (for example, a 401(k) plan) must also comply with Federal law, namely the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (the Code).

A qualified retirement plan under ERISA will require a Qualified Domestic Relations Order (QDRO or “Quadro”) to divide the investments in the account.  If prepared properly, the QDRO outlines every detail of the split so the plan administrator can complete the transaction accurately.

Other retirement plans, such as many traditional IRAs or Roth IRAs, may not require a QDRO.  Many of these plans require a copy of the divorce decree and custodian specific forms to divide the account.

2. Is a retirement plan more or less valuable when compared to other assets?

Retirement assets are only one part of a family’s total financial picture.  In divorce, unnecessary expenses and taxes can be avoided.  Moreover, liquidity is key to starting a financial life over again.  A Certified Divorce Financial Analyst® or CDFA® can be a enormous asset in the process of seeking the best after tax outcome in divorce matters.

Pension plans typically rate the lowest on the list of assets to obtain because those funds are not liquid today (unless you are at retirement age).  Further, each company offering a pension will have rules surrounding availability of the pension funds to the ex-spouse.  It’s wise to know the rules of each pension plan before you sign any binding documents.

Traditional or Rollover IRA’s typically rank lowest on the scale of available, liquid assets because withdrawals are usually taxed at the owner’s highest marginal tax rate and incur a 10 percent penalty until age 59.5 (although there are exceptions).

ERISA regulated plans (such as 401k’s) are one step above the Traditional IRA regarding assets available for liquidity as you can redeem cash from your ex-spouses 401k plan without paying the 10% penalty, but you still must pay taxes.  There is also a federally mandated 20% withholding on all cash distributions.  For example, if you want $80,000 in cash from your ex-spouses 401k, you’ll need to withdrawal $100,000 as 20% ($20,000 in this example) will automatically be forwarded to the IRS.  Lastly, 401k’s follow QDRO rules and it takes time for the QDROs to finalize.  Expect the QDRO process from beginning to “cash in hand” to last at least 3 months, if not longer.

ROTH IRA’s are the most advantageous retirement asset for liquidity needs during or after divorce.  The principal put into a ROTH IRA can be withdrawal, separately from the growth or earnings, tax and penalty free.  You’ve already paid tax on the principal in a ROTH IRA, you are not taxed on it again nor are you penalized on this portion of the ROTH IRA.  The earnings on the ROTH IRA will likely be subject to taxation and the 10% early withdrawal penalty (before age 59.5).  ROTH IRA’s have other quirky rules regarding a 5 years timeline.  Check with a CDFA on the specific rules surrounding your situation.

Non-retirement assets are generally better to obtain than retirement assets in a divorce.  Brokerage accounts will typically have some amount of principal which is already taxed, and the earnings may be taxed at a lower capital gain rate.

The home sale is proceeds nearly always rank high on the list of desirable assets.  A large share of gain from the sale of a primary residence (after closing costs are paid) is not taxed and, unlike most retirement plans, these proceeds are available to divorcing clients before age 59.5 without penalty.

Cash savings and checking accounts are, obviously, the most liquid.

divorce and your 401k

3. Is a retirement account separate property?

I hear so many people who own retirement accounts declare something along the lines of, “I worked.  I pulled in the money.  The 401k is mine!  I earned it.”  We agree, you have earned it!  However, in the State of Texas if you earned it during the marriage, it is a marital asset.  Typically, any funds brought into the marriage whether those assets went into a bank account, a hard asset or a retirement account are a marital asset subject to division in a divorce.

In contrast, retirement assets earned prior to the marriage are typically considered separate assets in Texas and not subject to division in the divorce.  In addition, the growth on those separate assets during the marriage is considered separate property.  However, any income (defined as dividends and interest, even if reinvested) attributable to the separate assets are considered marital.  Sound confusing?  We agree.  It is and separate versus marital can become a very complex, very quickly.

For an accurate appraisal of what portion of a retirement account is separate versus what portion is marital, a forensic engagement needs to be performed.  If the parties choose to keep things simple, a CDFA professional can assist attorneys by using the coverture fraction.  The coverture fraction can be used to calculate the community share and is defined as the ratio of the married years of earning the benefit and the employed spouse’s total earning period.  This way of performing the separate versus marital calculation is not as exact as a forensic engagement, but it gives the parties a good idea of how each tranche of assets should be characterized.

4. Can you avoid the IRS penalty for early withdrawal in divorce?

When the receiving spouse is awarded a share of a qualified plan like a 401(k), the share is most often moved to an alternate payee account inside the plan.  Under IRS rule 72(t)(2)(C), the alternate payee of a qualified plan can withdraw pursuant to divorce without early withdrawal penalties (10 percent), but ordinary income taxes will still need to be paid.  For a spouse with little or no income in the first year of divorce, this can be a source of liquidity to support his or her lifestyle.

The plan administrator will often withhold 20 percent because the alternate payee will be required to pay marginal taxes on any withdrawal.  The more the spouse withdraws, the higher taxes owed.

The alternate payee can often use a two-step withdrawal process to avoid penalties.  First, withdraw the cash needed and then either (1) leave the remaining proceeds in the alternate payee account or (2) roll over the account to a new IRA.  At the end of the year, the recipient spouse should receive a 1099 from the plan administrator for the withdrawal which indicates the 72(t)(2)(C) exemption.

tax law changes

5. Should you “tax affect” retirement accounts when dividing assets in divorce?

Many attorneys will “tax affect” retirement plans (discounting the account by the recipient’s highest marginal tax rate).  Left unchecked, the spouse receiving more of the retirement accounts may benefit (possibly unfairly) in negotiations from this practice.

In order to properly “tax affect” each plan or account based on economics, the parties would need to know when and how much will be withdrawn, future tax rates for each party, and the rate needed to discount the tax expense back to today’s dollars – even when the recipient is very close to retirement.

By preparing financial projections, a CDFA professional can assess the amount and timing of the recipient’s anticipated withdrawals from retirement accounts.  This is an excellent way to handle retirement accounts and divorce.  By discounting the future tax expense, the analyst can assess whether and how much to “tax affect” or discount the value of retirement assets.

Conclusion

Retirement accounts and divorce are exceptionally complicated.  Properly tax affecting and characterizing your estate is critical in divorce negotiations.  Having the right people on your team is one of the best ways to ensure you are receiving the settlement that’s best for you.