Dividing Retirement Accounts And Military Pensions In Divorce: What You Need to Know

Dividing Retirement Accounts and Military Pensions in Divorce: What You Need to Know

Dividing retirement accounts and military pensions in a divorce is a complex and often misunderstood process, particularly when dealing with military families. From 401(k)s and Thrift Savings Plans (TSP) to military pensions, each type of retirement asset is governed by its own set of rules. A proper valuation of these accounts, understanding the tax implications, and securing the appropriate court orders are essential to ensure a fair division. In this blog, we will discuss key issues surrounding the division of retirement accounts and military pensions in divorce, including the challenges of determining premarital and marital portions, the differences between tax-exempt and non-qualified accounts, tax ramifications, and the need for specific court orders to finalize the division.

1. Valuing Retirement Accounts: Premarital vs. Marital Portions

In any divorce, one of the first steps in dividing retirement accounts and pensions is determining what portion of the assets is marital property versus separate property. Marital property typically includes assets accumulated during the marriage, while separate property includes assets acquired before the marriage or by inheritance or gift.

For retirement accounts like 401(k)s and TSPs, this means that the value of the account at the time of marriage and any contributions made during the marriage need to be separated. A qualified financial expert or actuary is often necessary to accurately value the account, separating the premarital portion (which remains the property of the original account holder) from the marital portion, which is subject to division.

Military pensions, on the other hand, are governed by the Uniformed Services Former Spouses' Protection Act (USFSPA), which allows for the division of military retirement pay in divorce. The marital share of the pension is typically calculated based on the number of years the couple was married during the service member's military career, divided by the total number of years of military service. Accurately calculating the value of the pension, especially if the service member has not yet retired, requires detailed information about the High-3 pay (the average of the service member’s highest 36 months of pay) and creditable service.

2. Qualified vs. Non-Qualified Accounts

When dividing retirement assets, it’s important to understand the difference between qualified and non-qualified accounts:

• Qualified retirement accounts, such as 401(k)s, TSPs, and IRAs, follow the rules of the IRS and are generally funded with pre-tax dollars. Distributions from these accounts are taxable upon withdrawal, but they grow tax-deferred.
• Non-qualified accounts, such as certain deferred compensation plans, are not subject to the same IRS rules. These accounts are often funded with after-tax dollars and do not offer the same tax-deferred growth, but the tax rules around distribution are often more flexible.

Understanding this distinction is critical when dividing these assets. For example, a portion of a 401(k) transferred to a former spouse may maintain its tax-deferred status, but liquidating the account without following proper procedures can result in significant tax penalties.

3. Tax Implications of Liquidating Retirement Accounts

One of the most important considerations in dividing retirement accounts is the potential tax ramifications of withdrawing or liquidating funds. For example:

• 401(k) and TSP accounts are typically tax-deferred, meaning taxes will only be paid when funds are withdrawn. If either party chooses to liquidate the account instead of rolling it over or transferring it, they will face income tax on the distribution as well as a potential 10% early withdrawal penalty if the account holder is under age 59½.
• Military pensions, when divided, are considered taxable income for the receiving spouse. However, if the service member elects to waive part of their pension in favor of disability compensation, this could reduce the former spouse’s share, as disability pay is not divisible under the USFSPA.

It's essential for both parties to understand the tax consequences of any distribution or liquidation of these accounts. Seeking advice from a tax professional or financial advisor is recommended to minimize tax liabilities and penalties.

4. The Role of Domestic Relations Orders and Military Pension Orders

To properly divide retirement accounts and military pensions, specific court orders are required to ensure the division is legally enforceable. These include:

• Qualified Domestic Relations Order (QDRO): A QDRO is required to divide qualified retirement accounts like 401(k)s and TSPs. This court order instructs the retirement plan administrator to transfer a portion of the account to the former spouse. Without a QDRO, the plan administrator cannot make any payments to the former spouse, and improper handling could result in taxes and penalties for both parties.
• Military Pension Division Order: For military pensions, a specially drafted court order is required for DFAS (Defense Finance and Accounting Service) to divide military retirement pay. This order must meet the requirements of the USFSPA, including specifying how the marital share is calculated, the High-3 pay, and the number of years of military service that overlap with the marriage. Additionally, if the marriage lasted for at least 10 years and overlapped with 10 years of military service (the 10/10 rule), the former spouse may be eligible to receive direct payments from DFAS.

Securing these orders is critical for ensuring that retirement accounts and military pensions are divided correctly and without unintended consequences. An experienced attorney, especially one well-versed in military divorce, can guide you through this process.

Conclusion

Dividing retirement accounts and military pensions in a divorce, especially a military divorce, is a complex process that involves detailed financial analysis, tax considerations, and specific legal requirements. From valuing premarital and marital portions to understanding the tax implications of liquidation, every step requires careful planning. Additionally, securing Qualified Domestic Relations Orders (QDROs) or military pension division orders is essential to ensure that retirement assets are properly divided and protected.

Our firm, led by former JAG attorneys, is highly experienced in handling the division of military pensions and retirement accounts. We work closely with clients to protect their financial future, ensuring all legal and financial requirements are met.

For personalized advice and assistance with dividing retirement accounts in a military divorce, contact us today at 301-952-9000 or schedule a consultation using our online scheduling link (CLICK HERE).

Disclaimer: This blog is for informational purposes only and does not constitute legal advice. Reading this blog does not create an attorney-client relationship. For specific legal advice, please contact Patriots Law Group directly.