Separating Your Retirement Assets Pre-and Post Divorce
Separating Your Retirement Assets Pre- and Post-Divorce: Q&A Part 1 – By Nancy Kaye, CDFA, CFP
Question: “We're not divorced yet. How can I control my portion of the marital assets?”
Answer: One of the stickiest aspects of a divorce, and often the greatest point of contention, is the separation of financial assets.
The beauty of choosing the Collaborative Divorce process is that the decisions made between the soon-to-be ex-spouses are bound by what the couple wants, with guidance from their respective attorneys and the neutral professionals on the Collaborative Divorce team. Generally, the financial separation of assets is done at the time of the signing of the divorce agreement. However, it can occur at any time if agreed upon by the parties.
If a couple has already reached a financial agreement of how the marital assets should be divided, there is no need to wait until the divorce is signed. If each asset is split down the middle, it is an easy task; however the splitting method is not always the best strategy.
Question: Are asset transfers between spouses taxable?
Answer: No taxes are paid on asset transfers between spouses. However, two assets with the same current value may not really be equal. Thus, even if you split assets, you must know the value of the contribution made/invested in each asset. Knowing this “cost basis” will help in the division of assets for “tax impacting” when divided.
Question: How do we know what really is equal?
Answer: For example: The couple owns two brokerage accounts each worth $100,000. Account A started with a value of $75,000. Account B started with a value of $125,000. Are these accounts really “equal” when it comes to splitting assets “down the middle” in the divorce settlement? While it may seem easier to say to your spouse, “You take Account A and I'll take Account B,” in the long run this could be detrimental to your financial health.
If both accounts are sold today, Account A would have a capital gains tax on the $25,000 profit. At a minimum, that reduces the profit and account balance by $3,750 or 15% of the gain. Account B, when sold, will have a loss of $25,000 and will receive 100% of the proceeds or $100,000. Now do they still seem equal? Account B will have a $25,000 tax loss and potential “carry over” of that loss for future years. This in and of itself is a valuable asset that will help to reduce taxes going forward. Now you can see that all assets are not “equal.”
Question: What about our home? I am planning to keep it, but it's held in our joint names.
Answer: With the help of an attorney, you can change the ownership/title on the home to your name individually. There is no taxable transfer between spouses. When you do sell, as an individual, you are entitled to a $250,000 exclusion on any gain (what you purchased the home for, plus improvements, less your net selling price). As a couple, you would have been entitled to $500,000 exclusion before capital gains are paid.
Question: What if we plan on keeping the home jointly until our youngest child turns 18?
Answer: Again, you will need an attorney to change the title of the home to joint tenants in common. This way, if one of you were to pre-decease the other, your heirs would get your half of the home.
A qualified financial professional can assist with the tax implications of the division of assets.
Separating Your Retirement Assets Pre- and Post-Divorce: Q&A Part 2 – By Nancy Kaye, CDFA, CFP
The Collaborative Divorce process makes anything possible if the two parties can agree. Remember, you always want to have your attorney's input and guidance in the decision making process.
A Collaborative Divorce generally takes less time than a litigated settlement. The speediness of action is facilitated by openness, the sharing of information, and the desire to work out a settlement that meets the needs of the husband, wife and child(ren). Although one party may need more time than the other to sort out and accept the new family situation, a supportive collaborative team coach will help both parties work towards the “end game.”
In my last blog, I talked about the separation of non-retirement assets. Retirement assets are a bit different as they generally are separated after divorce. The reason is that corporations and brokerage houses require documentation that the couple is legally divorced, so that any transfer of funds does not trigger a taxable event.
Remember, most retirement assets (other than a Roth IRA) have never been taxed when contributions were made. All the earnings grow tax deferred. It is only upon distribution that the assets are taxed. If assets are withdrawn prior to age 59-1/2, the government assesses a 10% penalty for early withdrawal. While this penalty can be eliminated during the divorce process if one spouse requires the money, this must be done before the assets are transferred over. Although you would eliminate the 10% early withdrawal penalty, the money withdrawn still would be taxed.
Question: Does our tax basis affect our retirement assets like IRA's and Roth IRA's?
Answer: Retirement asset division is a bit more complex. Asset division typically follows this rule of thumb: “I'll take mine, you'll take yours, and we'll divide up the rest to make it equitable.” When retirement plans are eventually sold, there are taxes to be paid, since contributions and earnings have never been taxed. With Roth IRA's, the taxes have already been paid on the contributions and when the money is withdrawn, the balance comes out tax-free. So again, with Roth IRA's in the mix, consider the tax impact of each asset as if it were sold today, in order to get the proper valuation (see Part I for a further clarification of tax impacting).
Question: Can we divide up our retirement assets now – before the divorce is final?
Answer: It is important to know that prior to divorce, you cannot divide-up retirement assets – unless you are each keeping your own assets. If you will be receiving part of your spouse's individual retirement account, there is a way to take control. You can have your spouse set up another IRA account and deposit the designated portion into this new account, naming you as the beneficiary and as the “Power of Attorney”. This way, you can change the investment strategy to be more suitable to your individual financial goals and objectives. The financial statements can go to your new address. At the time of divorce, you can simply change the name on the account to your name.
Question: And what about the company retirement plans?
Answer: Corporate retirement plans (Money Purchase, Profit Sharing, Pension or 401K plans) require a QDRO (Qualified Domestic Relations Order) to be submitted to the employer in order to split-up the asset. Although this asset cannot be divided prior to divorce, at least you will be able to take control of some portion of your assets sooner, rather than later.
The qualified financial professional on the Collaborative Divorce team can assist you with the tax implications of the division of your marital assets.
Nancy Kaye is a Registered Principal with LPL Financial, Member FINRA/SIPC. Securities offered through LPL Financial, Member FINRA/SIPC. For a list of states in which Nancy Kaye is registered to do business, visit www.soundview-financial.com.