Funding a 401(k) can be a smart decision for a successful professional. The resources set aside in a tax-deferred retirement savings account can help augment pensions and Social Security retirement benefits. The use of a 401(k) can also help limit tax liability throughout a professional’s highest-earning years. In some cases, their employers may even match the contributions they make to the 401(k), helping them save rapidly for their comfort later in life.
Unfortunately, 401(k) accounts can quickly complicate California divorce negotiations. Under community property rules, whatever people add to the account during marriage is potentially at risk of division when they divorce.
How can a professional with a well-funded 401(k) minimize what they lose from the account during divorce proceedings?
Following the right procedures
Although sharing the value of the account may be necessary in many cases, it is still possible to avoid the penalties of making an early withdrawal. Removing funds from a 401(k) before reaching retirement age can lead to a 10% penalty. The withdrawal can also push someone into a higher tax bracket, which can affect their income tax obligations for the year.
If actually splitting the account is necessary to comply with a property division agreement or order, then using a qualified domestic relations order (QDRO) is typically the best choice. A QDRO can divide what remains in the account without triggering the penalties and tax consequences of a standard early withdrawal.
Balancing the account with other assets
Using a QDRO is a viable option, but spouses don’t technically need to divide a retirement account as part of the divorce. After determining what portion of the account is part of the marital estate, spouses could use other property to balance out the decision to allow one spouse to retain the account in its entirety.
Those worried about their security during retirement may want to retain their 401(k) without dividing it even if they have to make other property division concessions to do so. If they can compromise on other issues, they may be able to preserve the account.
Understanding what could happen to a 401(k) during divorce proceedings can help people plan for the future. Spouses who approach divorce with a strategy already in mind can prioritize achieving specific goals that may impact their future comfort.