Aside from the marital residence, I find that my clients' 401(k) plans are the second largest asset to divide through equitable distribution. With pension plans becoming all but extinct, individuals are depositing larger sums than ever into their 401(k) plans.
Below are some tips regarding the division of this retirement asset through equitable distribution.
Tip One: Identify the Pre-Marital Portion of the Account
Notwithstanding some very limited exceptions, a spouse’s interest in your 401(k) plan begins on the date of your marriage. It is likely that you were contributing to your plan prior to the marriage and it is important to identify the value of your account prior to the marriage. With many retirement plans only keeping records for seven years, it may be in your best interest to print out an account statement that corresponds from the date of your marriage.
In addition to retaining the funds in the account prior to the marriage, the growth on this portion of the account is also excluded from equitable distribution. With the compounding nature of interests within retirement accounts, it is important to remember to apply an appropriate growth rate the premarital portion of your account. The growth rate can be established by reviewing the account’s historic investment performance and simply compounding this level of growth to the exempt portion of the asset.
Tip Two: Identify the Post-Complaint Portion of the Account
Similar to the pre-marital contribution into your retirement plan, in most scenarios, the post-Complaint deposits into your 401(k) account are usually exempt from equitable distribution. With some divorce litigations spanning more than one year, the exclusion of these deposits can have a significant impact on your final equitable distribution scenario.
Tip Three: Make Sure to Take Into Account the Tax Status of the Asset
One of the key benefits of a 401(k) plan remains the pre-tax nature of the contributions. This tax deferral is useful for many individuals to lover their effective tax liability. However, it is a common mistake to utilize the value of a 401(k) plan to offset an after-tax asset such as the value of bank account. Due to the differing tax classifications, comparing the two is similar to comparing apples to oranges.
If you are going to offset the value of your retirement account to a cash asset, you need to first reduce the value of the 401(k) plan value by your effective tax rate. For purposes of example, if your effective tax rate is 25%, if you have $100,000 in your retirement account, the actual cash value of the account would need to be reduced by 25%, for a cash value of $75,000. Cash assets (bank accounts, equity in a primary residence, etc.) have already been taxed; therefore you do not need to reduce the values of these assets for tax purposes.
With pension plans falling out of favor or many of our employers, the protection of your 401(k) assets are more important than ever. I strongly recommend that you consult with an experienced matrimonial attorney prior to entering into an agreement to divide this asset through your divorce.