Married prospective retirees and current retirees beware: Your retirement savings depend more on the health of your relationship than they do on the markets.
Market drops are scary. Still, they're unlikely to cut your retirement savings in half. A divorce may.
Ex-spouses may end up with double the expenses, but half the nest egg.
As you near retirement, you'll need to figure out how much you'll need to retire comfortably. You should also consider the "what-if" of a divorce and it's potential impact on your 401(k) and other retirements savings.
Divorce statistics among older Americans are sobering. In 2015, the divorce rate among those over 50 was 10 divorces for every 1,000 married persons. That's double what it was 1990, according to the National Center for Health Statistics and the U.S. Census Bureau.
Retirement Savings: QDRO?
If your marriage is rocky, or there's a divorce in your past, you need to understand the term qualified domestic relations order (QDRO) Divorcing spouses file this order with a state domestic-relations court. It spells out how they will split the assets in their 401(k)s. Other retirement accounts, IRAs and pensions, are divided according to other rules.
Never heard of a QDRO? You're not alone.
An August 2020 report by the Government Accountability Office (GAO) stated that "few people seek and obtain QDROs." The report says the Pension Benefit Guaranty Corporation (PBGC), a U.S. government group that administers retirement benefits, approved only about 16,000 QDROs in the past 10 years. During that time, the PBGC handled retirement benefits for about 1.6 million participants.
"I would say less than 50% of people even know what a QDRO is," said Geneen Von Kloha, a financial advisor with the Moneta Group, headquartered in Clayton, Mo.
That's disturbing. Assets in 401(k)s represent a huge and growing part of the U.S. retirement market. As of June 30, 2021, 401(k) plans held an estimated $7.26 trillion in assets or roughly one-fifth of the $37.2 trillion U.S. retirement market, according to Investment Company Institute (ICI), Washington DC. Back at the end of 2001, 401(k) assets were $3.1 trillion, about 17% of the U.S. retirement market.
Divorce Asset Split
Usually a divorce attorney drafts a QDRO, says Laura Medigovich, director of advanced planning at Janney Montgomery Scott, Purchase, N.Y. Then the 401(k) administrator executes the order, following a plan's rules.
"A QDRO is done in conjunction with a divorce and it needs to be done before the divorce decree," said Medigovich.
Of course how much of a 401(k) goes to each divorcing spouse is a negotiation. The state in which a couple lives sets the overarching rules. In nine community property states, assets acquired during a marriage are generally divided 50/50. Assets acquired prior to marriage or through an inheritance are typically outside the divorce.
In "common-law states," courts divide marital assets "equitably." However, each court decides what that means.
Some people facing a divorce may want cash or real estate now, instead of part of a retirement account. That can be shortsighted, especially when considering your retirement planning.
"Taking $500,000 in cash — it's not the same as $500,000 in a 401(k)," said Medigovich. Long term, a retirement account will presumably grow, and grow tax-free. To get a picture of how much retirement savings you'll need, some people use a retirement savings calculator.
Medigovich says parties to a divorce should consult financial advisors and attorneys. If you need money during a divorce you can take out some of your negotiated portion of the 401(k) without penalty, even if you're under 59-1/2, explains Medigovich. But you'll have to pay tax on that withdrawal. You can leave the rest in retirement savings, growing and earning tax-free.
Drafting a QDRO isn't cheap, nor is it speedy. Still, beware of sample QDROs from a plan administrator. Using one of these might be easy for the administrator, but how a spouse receives a slice of the 401(k) should be based on his or her needs.
No QDRO? Better Like Your Ex's Investment Choices
Can you leave your cut of a 401(k) in your ex's plan? Yes. But advisors say that's a bad strategy.
"Your risk tolerance might be very different than your ex's risk tolerance," especially down the road, said Von Kloha. And, your other assets may change in value, altering your financial view. These are reasons to do the QDRO as you divorce, then make your own decisions on investing your portion of the 401(k) money.
Plus, after a divorce there's "the issue of beneficiaries," said Von Kloha. If your ex dies, your ex's new beneficiary (potentially a new spouse) may end up making investment decisions about the 401(k). And after the divorce you'll want to name the beneficiaries you want to inherit any assets that come to you from the split.
Lastly, the risk of a later lawsuit, reopening the divorce settlement, is real in any divorce. And it may be more likely if former marital assets are still comingled.
