Division of Retirement Accounts in Divorce
Before we discuss the method of division of pension plans, we need to identify the different kinds of pension plans and whether they are vested or unvested.
One kind of pension plan is a Defined Benefit Plan. These plans are usually only funded by the employer and promise the employee that the employer will pay a monthly payment to the employee once the employee reaches a certain age. The longer you work for the employer, the bigger the month amount.
Another kind of pension plan is a Defined Contribution Plan. In these plans the employee agrees to deposit money into an account and the employer agrees to deposit money into the same account. This is why it is called a Defined Contribution Plan, both employee and employer are contributing to the pension plan. In these plans the contribution of the employee and employer are deductible on federal tax returns. The federal government also allows the employee to borrow from these plans, provided there is an agreement to pay it back within 5 years with interest.
The amount borrowed cannot be more than half of the amount contributed to the plan but not more than $50,000. Withdrawal from these plans without an agreement to pay it back before a set retirement date, usually 59 ½, would result in a 10% penalty and ordinary income taxes.
These plans come with names like 401k, 403b, Savings Plans and other similar names.
Another kind of Pension Plan is known as an IRA. In this plan, the individual is the only contributor; the amount contributed is tax deductible and there are no withdrawals without penalties and taxes until you reach the age of 59 ½.
There is a similar IRA that is called a Roth IRA. In this IRA, the individual is the only contributor and the contribution is not tax deductible. However, there is no tax when there is a withdrawal after 59 ½.
What is Vesting? Vesting is a term describing when the retirement funds are all yours and not subject to being taken away. Historically, pension plans were for the purpose of keeping skilled employees from leaving and pension rights were lost if an employee left before he or she was vested. Employers would usually have long vesting periods. 20, 25, and 30-year vesting periods were normal. So, if a plan required a 20-year vesting period and you left your employment after 19 ½ years of employment, you forfeited all of your rights to the pension.
Today the federal government requires that the vesting period be no longer than 5 years.
So, on Defined Benefit Plans, after 5 years, you would be entitled to receive the monthly benefits when you are allowed to retire that was earned by you in the 5 years you worked for that employer.
On Defined Contribution Plans, you vest immediately on sums deposited by you. However, funds deposited by the employer do not vest unless you reach the required work years as formed by the Plan. Some employers allow immediate vesting and some employers would have vesting of 1/5 of their contributions per year.
What happens in a divorce? Except for IRA’s, a participant’s spouse has an interest in the pension plan by federal laws. A spouse may have a marital interest in an IRA. Further, all Defined Contribution Plans are portable; meaning that you can take the funds with you when you leave your employer. All pension plans vested and/or unvested by the law of the State of Michigan are divisible in a divorce context by state statute.
The division is done by a judge signing what is known as a Qualified Domestic Relations Order (QDRO). To divide IRA’s all that is necessary is an Assignment to be signed by the judge.
Lawyers draft these documents (QDRO’s) in accord with the orders of the Court as described in the Judgment of Divorce. QDRO’s are very technical documents and many lawyers send them to other attorneys who have become experts in understanding the terminology and the rights that are found in the body of the pension plans.
Every employer has its own spin on what rights are conferred in a plan and so most plans differ from other plans.
In Defined Benefit Plans, there may be survival rights; there may be increase in amounts payable; there may be early retirement rights; there may be lump sum distribution rights; there may be forfeit rights.
One must be extremely careful and knowledgeable in drafting QDRO’s.One word in the wrong place can deprive you of significant rights.
Call Ross Stancati today at 269-381-4471 to discuss your retirement account and divorce.