It’s a scene played out across every dining room table, in every home where marriage is starting to crumble quicker than an Alaskan glacier caught in the crosshairs of global warming. It’s a domestic math problem; division—who gets the house, who gets the furniture, who gets Fido, who gets the kids, etc. Until the conversation turns to perhaps one of the stickier questions: Who gets what stocks? Then things can get really ugly. For the most part, we are talking about equitable distribution states.
The easy solution is worthy of King Solomon; each partner gets to keep all stocks, but only after they’ve been split. But you may want to take a deeper dive before you split those stock assets. After all, one spouse may have an emotional attachment to stock or investment. For instance, one spouse may want to keep that Amazon stock purchased years ago while the other just bought stock in Facebook of equal dollar value. But be careful here because the Amazon stock may have a much lower basis then the newly purchased Facebook, therefore embedding a larger tax liability for the spouse wanting to keep Amazon.
Another point to keep in mind is that certain assets may be treated differently upon sale, such as a primary residence which, if certain conditions are met, carries a $250,000 capital gain exclusion available for each spouse. Together, that adds up to $500,000 for the marital couple. If the ultimate objective is to sell the house, then it would make more sense to sell it while the couple is still technically filing a joint tax return to avoid major capital gains if they exist. This is a better alternative than transferring the primary residence to the other spouse and have that spouse sell the house a short time later, only to lose one of the $250,000 exclusions.
Fortunately, when it comes to dividing up an IRA or retirement plan’s assets (also known as Qualified Plans) you don’t have to pay taxes. There is a proper way to handle these assets that will allow for the continued deferral of Qualified Assets. In the case of an IRA, there is a process known as “transfer incident to divorce.” In the case of Qualified Plans, such as a 401(k) or Tax-Sheltered Annuity Plan, 403(b), these assets are split under the Qualified Domestic Relations Order, otherwise known as QDRO for short. Each of these will allow the spouses to split the assets without any tax consequences. It is important, however, to make sure that each of these accounts is labeled properly when giving information to the court for division. This is important because QDROs only pertain to those assets mentioned above and not IRAs.
Once investment and retirement assets are split, you will want to explore your newly found goals and objectives.
In addition, QDROs carry broad federal protection from creditors under ERISA (Employee Retirement Income Security Act), while IRAs may have different protections under different state rules. In both cases, once the transfer is made the recipient will have full control of their own retirement assets. This means the recipient is also responsible for taxes and, in certain circumstances, any penalties for premature distributions before the age of 59 ½ and must start taking required minimum distributions in the year in which they reach age 70 ½.
Remember, any lack of attention to detail when it comes to separating these assets can complicate the process and create more of an expense, especially if there is a lot of money at stake. This brings us to the topic of pensions and divorce. While pensions are becoming more and more extinct, a pension earned while married, in most cases, is a joint asset. State courts make the final decision on how those assets are divided, as well as any survivor benefits. Social Security and certain railroad retirement benefits need a court order to get a share of the pension. With many retirement plans, when pension assets are split according to certain requirements put forth under a Domestic Relations Order, the benefits will be paid directly to the divorced spouses. In the case of some states, counties, and cities, direct payments to divorced spouses may not be an option.
Rules for the division of pensions can get very complicated from state to state and between different retirement systems. Now, even though the state laws will dictate how much retirement assets a divorcing spouse is entitled to, if the two parties can agree then there is an option to split these assets in a fair manner independent of the courts. However, in doing so you might still need a financial advisor to navigate you through the complexities and tax ramifications that are part of a divorce.
Lastly, once investment and retirement assets are split, you will want to explore your newly found goals and objectives as they may be much different than previously. This includes taking a closer look at your overall investment strategies and risk tolerance.
Remember, this is only meant to highlight some of the major considerations of investment and retirement assets that often arise in the case of divorce. There are many other items that should be discussed. For more information contact me at RStabile@higbieadvisory.com.
Robert Stabile owns Higbie Advisory, LLC a Registered Investment Advisory located in Melville, Long Island. He has over 30 years’ experience in personal risk management and has spent the last eight years as an investor coach dedicated to helping clients understand their true purpose for money, understand what Wall Street costs them and delivering Nobel Prize Investment. Strategies that meet the Prudent Man’s Rule of Investing. Higbie Advisory, LLC is partnered with Matson Money, an ERISA 3(38) fiduciary. Robert Stabile’s articles have appeared in such well-respected publications as “Small Business Today Magazine,” “Long Island Business News,” Providence Business News, and others. He can be reached at firstname.lastname@example.org.