Colorado is an “equitable division of marital assets state” that compels divorcing spouses to divide and distribute all assets and debts accumulated during the marriage fairly between both spouses. For many divorces, one or both spouses’ 401K retirement plan is the largest marital asset and is subject to division during a divorce. Some spouses may seek a fast answer to dividing 401K savings so they can expedite the divorce process, but it pays to carefully consider the best way to divide this valuable asset instead of cashing it out. You should always consult with your Denver divorce attorney and/or financial advisor before making a hasty move. The way you split a 401K or IRA plan has serious tax implications to consider and minimizing the tax penalty makes a significant difference in the amount each spouse retains after a divorce.
Why Do I Have to Split My 401K Savings With My Spouse?
Many spouses become alarmed when they learn that their 401K savings are subject to division during a divorce. They may feel like the money belongs solely to them if their name is on the account and the savings comes through their job and earnings and not their spouse’s. However, in states that demand the equitable division of marital assets like Colorado, all accounts opened or added to during a marriage belong equally to both spouses regardless of whose name is on the account.
If you began your 401K retirement plan before your marriage, any amount accumulated in the account before your marriage is yours alone, however, the amount of money accumulated during the marriage is subject to equal distribution with your spouse.
Should I Stop Contributing Funds to My 401K During a Divorce?
Speak to your Denver property division attorney and/or a financial advisor before making any changes to your 401K and any other savings or investment plans during divorce. Moving or withdrawing funds can appear as though you are hiding or disposing of assets to avoid dividing them with your spouse.
In most cases, there is no penalty for temporarily stopping any further funds from going into a 401K plan during the divorce process. Anything you earn after separating from your spouse is your separate property, but interest on an account begun during your marriage is joint property. This becomes quite complex, but a temporary halt on contributions can help minimize the confusion and also give you more money in your paycheck during the divorce process. You can restart your contributions after finalizing your divorce once your spouse already has their share and the account is yours alone.
Qualified Domestic Relations Order (QDRO) and Divorce
The most commonly recommended way to split a 401K is by using a Qualified Domestic Relations Order. This is a court order often issued during the divorce process to permit the transfer of funds from the participating spouse’s 401K plan to the non-participating spouse. The non-participating spouse (the one whose name is not on the account) can choose one of several options to receive their portion of the 401K funds:
- A direct rollover of their share into an existing IRA or a newly opened IRA account
- The plan provider can open a new account in the spouse’s name and roll over their share of the planholder’s account into the spouse’s name. The interest on their amount grows separately and they can choose to withdraw the amount at their own risk of tax penalty, continue to let it grow, or roll it over into an IRA or other retirement account
- Take a partial lump-sum distribution of the amount and rollover the remainder into an IRA with the amount of the distribution subject to income tax
- Take a full lump-sum distribution subject to income tax as well as a 10% penalty for early withdrawal if you are over age 59.5.
There is no tax burden or penalty for rolling over a spouse’s portion of a 401K into a separate 401K account or into an IRA, but withdrawing an amount for immediate distribution comes with taxation and possible penalties for early withdrawal. Taxes and other penalties for cashing out can equal up to 40% of the original amount.
Withdrawal of a court-ordered amount only comes with early withdrawal penalties for those over the age of 59.5 in Colorado.