401k Retirement Plans and Divorce

401K Retirement Plans and Divorce.
   

A divorce settlement can be excruciating. It is not always patient; it is not always kind. It can be rude. Self-seeking. Easily angered. And if you've developed a comfortable nest of 401k funds, you may find these benefits at the center of your divorce settlement maelstrom.

   

I've seen 401k participants who've been abandoned by their spouses. Participants who've been left with kids to support and a household to run. I've also seen participants with huge account balances doing irrational things - like forbidding plan administrators to work with their spouse's divorce lawyers - all in an attempt to keep their spouses from getting any of the retirement benefits.

Your desire to protect your funds may be self-seeking. Or it may be a matter of survival. But either way, your spouse has the legal grounds to claim all or part of your 401k benefits in a divorce settlement. And in most cases, you'll have to find a way to make a fair and equitable split of the funds. By being organized, prepared and knowledgeable about your legal options and rights, you can split your 401k reasonably.

Know Your Plan, Know Your Options

When deciding how to divvy up your 401k account with your soon-to-be ex, start by discussing options with your plan administrator. A lot of what you can do with your 401k is directed by the plan.

Each plan has its own set of benefit provisions and administrative rules. While some plans divide earnings by percentage, others divide by shares. And while some permit a distribution of the ex-spouse's portion at the time of the divorce, others require recipients to wait until retirement. Before you talk to your lawyers and financial planners and accountants - and well before your divorce decree is drafted - you need to do your own research into your plan's guidelines. And don't expect anyone else to do it for you, because in many cases, they won't.

The Equitable Split: Four Common Options

Once you've researched your plan administrator's rules and stipulations, you'll likely have one or more of the following options for dealing with your 401k in the divorce decree.

Option 1: You keep all of your 401k, and your spouse takes other marital assets of comparable value.

This option is sometimes cited as the least complicated from the attorney's point of view, but it requires careful research and financial calculations. If you choose this route, you'll need to consider at least two economic factors to ensure that you and your spouse remain on equal financial footing: 1) your long-term tax consequences and 2) the current and long-term values of the assets being divided.

You'll need to subtract the imputed tax - the tax you'll eventually have to pay on the amount in your account - from the value your 401k will hold at the time of your retirement.

On the other side, your soon-to-be ex will want to weigh the long-term value of the 401k against the long-term value of the assets he or she is receiving. For instance, if your 401k is worth $100,000 at the time of the divorce, and you have a fairly long time horizon until retirement [during which your account will earn compound (tax-deferred) interest], your 401k may be worth much more than $100,000 at the time of your retirement. Your ex will want to ensure that his or her share of the marital assets will be equally valuable over the long haul.

Option 2: You and your ex-spouse split the 401k assets.

If you want to split your 401k account with your ex rather than hashing out a division of marital assets equal in value to the 401k, then you will need a Qualified Domestic Relations Order. A QDRO (pronounced "quadro") is a court order that creates the right for an alternate payee (in this case, your ex-spouse) to receive all or part of your plan account. The QDRO must be a judgment, decree or order that is made pursuant to a state domestic relations law and relates to the provision of child support, alimony payments or marital property rights.

The least complicated procedure is often for the QDRO to stipulate that your 401k plan will be split into two accounts. This would enable you to continue to manage and contribute to your account as before, while your ex-spouse could make investment choices for his or her account, but not contribute to it. When you retire and become eligible to receive distribution of your funds, most 401k plans are set up so that your ex-spouse will also be eligible for distributions.

If you choose to divide your 401k, you may have to iron out issues such as repaying an outstanding loan, and how to allocate any earnings or losses that occur between the date of the divorce and the date the QDRO is made effective by the plan administrator.

The drafting of a QDRO is a sensitive spot because many divorce lawyers don't investigate a particular pension plan's guidelines before giving advice to clients on separation agreements, they often submit inadequate QDROs to plan administrators. And if the QDRO contains vague language or doesn't conform to plan guidelines, your plan administrators will reject it. It will then have to be re-drafted by your lawyer or your ex-spouse's lawyer. This, of course, results in additional fees. And more emotional hardship.

Because of problems with QDROs, I've seen lag times of several months - or even years - before QDROs were accepted by plan administrators and the 401k plans were actually divided. It takes an emotional toll. People feel like their divorce will never go away.

The moral? Understand your plan administrator's guidelines for splitting the 401k before your attorneys begin drafting the QDRO. Share this information with your attorneys. And begin the drafting process early in your discussions, so you'll have time to get it accepted by the plan administrator as part of the divorce settlement.

Option 3: You liquidate the portion of your account that is needed to satisfy the QDRO, and you give your spouse a lump sum.

This option is generally available only if you meet the rather complex legal requirement to permit such a distribution. Because of the tax consequences, this will probably be the least desirable option for both you and your spouse. Except in a few extreme situations, liquidating is not a good idea. But if you are the one trying to get part of your spouse's 401k, and you need the cash to pay off credit card debt or to maintain a separate household while your divorce is pending, this may be the least ugly of an unattractive array of options.

If it is your account, and part of it is liquidated for your spouse, you might want to make certain that your spouse is liable for the tax consequences. Your agreement needs to be clearly drawn so that the language clealry reflects that the tax liability is borne by the spouse receiving the benefits.

Option 4: Roll the portion of the 401k awarded to the ex-spouse into an IRA.

This option is only available if you've left your company or you're over the age of 59 ½. The benefit here is that a rollover permits you to remove your ex's share from your 401k plan without any penalty or tax liability. It also gives your former spouse an opportunity to choose from a wider array of investment choices, and to exercise more self-direction in account management.

If Both Spouses Have 401k Accounts

If you each have your own 401k, the division will depend on the dynamics between the two of you, says Johnson, as well as your account balances. Some couples can't agree on anything but a 50/50 split of all assets, including both 401ks. Other couples are happy to avoid the QDRO paperwork and simply each keep their own 401ks. In cases where one spouse's 401k balance is much larger than the other's, a solution may be for the person with the smaller balance to receive part of the other person's account.

A Kinder, Gentler Divorce

The financial storms that swirl around a divorce settlement can wreak havoc on your pocketbook, your emotions and your dignity. I've seen some difficult stuff.  I've seen participants who haven't acted with the necessary respect and knowledge, and I've watched them lose everything.

It doesn't have to be this way. By making it your goal to be knowledgeable and fair-minded when negotiating the split of your 401k, you can protect an equitable share of your financial assets. And you can keep an even larger share of your emotional well-being.

Seven Tips To Being In Control

You must enter into the process of splitting marital assets with your eyes open. You need to be fully informed. If you're not careful, you can end up losing your whole benefit.

The following tips can arm you with the knowledge you need to avoid both headache and heartache when splitting your 401k.

1. Ask your CPA and your financial planner for advice. Because tax consequences and liability will be different for each participant depending on age, income bracket and other factors, it's essential that you discuss the specifics of your situation with a finance and accounting professional.

2. Ask your plan administrator for model copies of QDROs.

3. Ask your plan administrator for guidelines and a checklist for preparing the QDRO. Some large employers will provide QDRO kits to help you. When researching your plan's guidelines, amass all the literature you can, and read it carefully.

4. Give both sets of lawyers copies of all guidelines and documents you receive from the plan administrator.Make it your job to ensure that both sets of attorneys are familiar with your plan's guidelines. It's essential that the claim submitted complies with the plan,  and it's all too common for claims to be filed erroneously.

5. Make sure that QDRO is prepared at the time of the divorce.

6. Sign the QDRO when you sign the separation agreement. Your divorce decree will be one crucial step closer to finalization once you sign the QDRO. And if you don't sign it with your separation agreement, you'll be one step further from bringing your divorce to closure.

7. Factor your spouse's benefits into your negotiations. The options and provisions for splitting a 401k apply to all retirement benefits. By factoring your spouse's retirement benefits into the negotiations, you may be able to hold on to a larger portion of your 401k.

The information provided here is informational only,  intended to help you understand the general issue, and does not constitute any tax, investment or legal advice. You are advised to consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

All the best in 2015.

#divorce
#401k


THIS HOLIDAY SEASON: A BRIGHT AND HOPEFUL FUTURE

THIS HOLIDAY SEASON: A BRIGHT AND HOPEFUL FUTURE

 

 

                The Holidays Season is upon us. It’s a time to gather with family and friends, and enjoy the accompanying spirit of comfort, hope, and good will. It’s a time for reflection upon what is “most important” to each of us. A time to reassess our current circumstances as measured against our future goals. This can be difficult for many even as a mere proposition. For whatever reasons, many find it difficult to navigate through the everyday stresses associated with the Holidays:  financial setbacks; lost love ones; family/friendship and the uncertainty of it all. For those who have either just forged their way through the process of divorce, are on the precipice of jumping into the process, or perhaps even navigating their way through the process now, these stresses are exponentially compounded.

 

             I have represented clients through the process of Divorce for the past 17 years.  Over those years, I have witnessed the anguish experienced by the parties and its long-lasting effects – especially during the Holiday Season.  In speaking with clients who I have represented, they have shared with me many kernels of wisdom which they gathered after going through the process which enabled them to cope and, ultimately, overcome the many of difficulties associated with Divorce.

 

       1.      Breathe

           

            Divorce imparts uncertainty and, among many, uncertainty breeds despair. We all know that Despair is a dark and lonely place.  If you enable it, it will shackle you in place and just as you catch and hold your breath when you are afraid, you forget to breathe and move.  You must understand that these thoughts are dependent upon the past which was, itself, bound in uncertainty. But now, just as you open your eyes and catch your breath to each new day, envision that you are now awakening anew: your slate is clean. Your future is a blank canvass whereupon you are now free to create. Create a new you.  Awaken to the endless possibilities that are now available to you; breathe in the fresh new breath of your future and feel the power it imparts.

 

2.      Gather Together and Tend To Your Assets

 

            Of course, when I use the term assets, many will automatically think to themselves: “Here comes the lawyer-boy side of Jim.”  I laugh a little with the thought. However, as well all know, those kinds of assets are of fleeting quality. They don’t define your place in the world or WHO you are, they are merely a reflection of A place in A time where you’ve been – and  through the process of Divorce, their true value comes to light as they are relegated to mere numbers on a pink or purple piece of paper to be handed to the Court.  The assets I am speaking of are the only true assets in the sense that they contribute to who you are:  your family, your friends, and your sense of belonging. Each of these assets all work in combination with the other.  Your families are your roots, your friends are your branches, and your sense of belonging is the air you breathe.  Cultivate and repair your roots, and prune the branches which no longer contribute to and increase the majesty that is you. Stand tall in the new air you breathe. Your assets will now fortify you as you forge off into your new future.

 

3.      Recreate You

 

            The circumstances of Divorce are the result of a multitude of personal relationship issues. I will not attempt to list them all out here. What I will do, however, is ask you to evaluate those circumstances as objectively as you can. This is the first step towards recreating you. Evaluate, comprehend, and accept your strengths and weakness in the relationship. What did you have too much, and not enough, of? What prevented you from being able to change these circumstances? What was it that held you in place, unable to move? This understanding is your NEW strength and the NEW YOU.    There is an inherent power in this understanding.  No longer are you bound in the past. No longer are you imprisoned in the strife of an unhealthy relationship.  No longer are you stuck in one place. Did you want to go out dancing more? Go out dancing! Did you want to spend more time with family and friends? Do it! Did you want to embark on a new career path? Well? Your potential and the possible ways to achieve that potential are boundless.

 

4.      Share the New You

           

            There is no doubt that there is an alienation that accompanies the process of Divorce. Former associations are splintered [if not outright severed] and an identity comfort zone which was tied to those associations is gone. You now feel alone and, well, ambiguous.  This is normal. However, do not let this become your new comfort zone. Perhaps you were too comfortable with those old associations. Perhaps you allowed those associations define who you were. If so, this new disassociation is just what you needed. You needed to be confronted with this ambiguity to fully comprehend that you had lost yourself. Now you can rise above those ties and venture upon a new future as the real you. Rather than allowing your associations to define you, now YOU define your surroundings. You are free. Share this freedom Surround yourself with those who you know love you for who you are, and not what you are or what you have and whether you are happy or sad; invite those into your world who are going to increase you and reinforce your potential in every conceivable way; don’t be afraid to laugh and smile more than you ever have; be tolerant, be caring, be kind; be industrious; be creative; and most importantly, share this new you with the outside world.

 

                Of course, I have shared these thoughts with the intention of providing insight from people who have navigated though the troublesome process of Divorce to guide those now facing the same process. However, upon closer observation, each of these insights applies equally to all, regardless of our circumstances.

 

            With that in mind, The Law Office of James Thomas Kinder wishes each of you a Happy, Healthy, Safe, and Bright, Holiday Season and beyond.

 

 

 

 

 

Peace and Love

Spousal Lifetime Access Trusts

In late 2012, a new estate planning strategy emerged - the so-called "Spousal Lifetime Access Trust" (or SLAT for short). The basic concept of the SLAT was relatively straightforward: it would function like a bypass trust, but be funded during life instead of at death, with the intention of using it to take advantage of the then-current $5.12M estate tax exemption before it dropped back to $1M as was scheduled for 2013.Ultimately, the estate tax fiscal cliff didn't happen, but the SLAT remains valid in 2013 and beyond for a new purpose: planning around state estate taxes, and the mismatch between the numerous states that have only a $1M state estate tax exemption and no gift tax, while the Federal gift and estate tax exemptions are at $5.25M. Given this "decoupling" of the state estate tax from its Federal gift tax - and the lack of any state gift tax backstop - couples have a unique opportunity to manage or avoid state estate taxes by creating "supercharged bypass trusts" in the form of SLATs funded during life.The caveat to the strategy is the "reciprocal trust" doctrine, which can cause SLATs to become "uncrossed" and taxable in the original donor's estate. Fortunately, reciprocal trust treatment can be avoided. Unfortunately, though, the rules to avoid reciprocal trust treatment are based on the facts and circumstances of the situation, and consequently a focus for the IRS and estate planning attorneys in the coming years may be figuring out how best to avoid the reciprocal trust doctrine without actually ruining the client's financial and estate planning goals.Nonetheless, though, the reality remains that the SLAT may be increasingly popular in the coming years, at least until states implement a gift tax, recouple to the Federal gift and estate tax system, or just repeal their state estate taxes entirely.

Purpose And Prior Use Of SLATs 

The basic idea of the Spousal Lifetime Access Trust (SLAT) is that it functions similar to a bypass trust, providing access (albeit limited, just as with a bypass trust) to income and/or principal for the needs of a surviving spouse. The difference, however, is that a SLAT is funded via gift while the donor is still alive, as opposed to a bypass trust that is funded by bequest when someone passes away. As with a bypass trust, the SLAT can provide access to just a spouse or a spouse and children, may automatically distribute income or make income distributions discretionary, and may prevent any distributions of principal or also allow principal distributions at the trustee’s discretion (which in turn may or may not be limited to distributions for health, education, maintenance, and support, depending on the trustee). The fundamental goal, similar to a bypass trust, is to get assets into a trust that can still provide some financial assistance to a beneficiary, but done in a manner that those assets - and any future growth upon them - will not be included in the beneficiary's estate.SLATs became especially popular in late 2012 asa vehicle to receive $5.12M gifts from high-net-worth clients who wanted to take advantage of the then-current gift tax exemption which would have potentially dropped down to only $1M in 2013 with the looming fiscal cliff. For instance, imagine a couple that had $20M of total net worth. Under 2012 law, they had combined $10.24M of exemptions, leaving only $9.76M exposed to estate taxes. With the exemption scheduled to fall down to $1M in 2013 though, there was a risk that their estate tax exposure would rise from only $9.76M to a whopping $18M (exacerbated further by the fact that the estate tax rate was scheduled to increase from 35% to a top rate of 55%!). To avoid this result, the couple could each fund $5.12M into a SLAT for the benefit of the other spouse in 2012, reducing their assets outright down to $9.76M and limiting their exposure to estate taxes in 2013. Of course, such gifting would utilize the couple's entire lifetime exemption, but it was viewed as far more favorable to use the whole exemption when it was $5.12M, than wait and risk only being able to use a $1M exemption in the future!

SLATs in 2013 And Beyond

Of course, the need for a SLAT to plan for a potentially-declining estate tax exemption ended with the American Taxpayer Relief Act, which permanently locked in the 2012 estate tax exemption and rate going forward, and won't be necessary again for such purposes until/unless a new law is passed that will definitively schedule the estate tax exemption to be reduced (notably, the President's 2014 Budget did include such a recommendation to take effect in 2018, although it remains unclear whether the proposal will gain any momentum). However, even without a looming decrease in the estate tax exemption, it turns out that under current law there's another popular reason for some clients to consider SLATs: the mismatch between the Federal gift tax exemption and state estate tax exemptions.The issue at hand is that there are still 22 states (soon to be 21) that have a state gift or inheritance tax, but only one of them (Connecticut) actually has a gift tax. About half a dozen have some type of gift-in-contemplation of death rule (which essentially states that gifts made shortly before death will still be included in the decedent's estate as though the gift never occurred), although their rules and details vary. For the rest of the states, there simply is no gift tax, even though many of these states have an exemption of only $1M. The opportunity this creates: to plan for state estate taxes using SLATsinstead of bypass trusts.For instance, imagine a couple that has a combined net worth of $4M (held as 50/50 between the couple). The couple currently has no exposure to Federal estate taxes, but live in a state that applies a state estate tax of 16% on assets above $1M. If the husband passes away, he can leave up to $1M in a bypass trust for his wife, with the remaining $1M left outright to his wife (and eligible for the marital deduction). Going forward, though, the wife now has $3M of net worth, which exposes her to a potential estate tax of $320,000 (the excess $2M above the state exemption at a 16% rate). However, if the husband chooses to fund a SLAT, he can put all $2M into a trust for his wife's death before he passes away; as a result, his wife will only be exposed to state estate taxes on her own personal $2M net worth, which is only $1M above the threshold and thus only exposed to $160,000 in estate taxes. The net result - by using a SLAT, the husband can put allof his assets into a SLAT to keep them out of his wife's estate, instead of being constrained to "only" the $1M state estate tax exemption that would apply when funding a bypass trust at his death.Notably, SLAT strategies may also become very popular for higher net worth clients as well. After all, if the client’s goal is to fund a bypass trust with the Federal $5.25M exemption, doing so at death can result in a state estate tax liability of $680,000 (at 16% state estate tax rates on the excess $4.25M that goes into a bypass trust but is above the state estate tax exemption); however, if the bypass trust as a SLAT is funded during life instead, the client may be able to put the entire $5.25M into the trust without any of the $680,000 state estate tax exposure!One challenge of using SLATs is that, because neither spouse is deceased yet, it’s not always clear which spouse should fund a SLAT – the husband for the wife, or the wife for the husband? To the extent that it’s intended as an alternative to a bypass trust with a higher dollar amount, the goal may be to fund a SLAT from any spouse in poor health – and anticipated to pass away soon – for the benefit of a surviving spouse, truly establishing a “super bypass trust” funded during life to avoid future state estate taxes. In other situations, though, this may not be feasible, either because gift-in-contemplation-of-death rules require that the trust be funded sooner rather than later, or simply because both spouses are in reasonable health and it’s not clear which may pass away first (but there’s a desire to take some planning action). The easiest resolution to this is to simply have both spouses create SLATs for each other with some of the assets (so that each spouse removes some assets from his/her estate). In this approach, each spouse would keep enough such that the spouse’s individual assets that are kept, plus the SLAT assets for his/her benefit, would be enough to maintain his/her lifestyle as a surviving spouse. The important caveat, though, is that IRS rules are not favorable to so-called “reciprocal trusts."

Avoiding The Reciprocal Trust Doctrine

The so-called "reciprocal trust" doctrine essentially states that if Person A creates a trust for B, and Person B creates an identical (i.e., reciprocal) trust for A, that the courts can "uncross" the trusts and treat the situation as though each person created a trust for his/her own benefit. Thus, if a husband created a $5M SLAT for his wife and the wife created a comparable $5M SLAT for her husband, the IRS may well claim that the end result is simply that each person made the equivalent of a $5M trust for themselves... which would cause the trust to be included in each individual's estate under IRC Sections 2036 and/or 2038 (since the deemed donor to the trust is the beneficiary of the trust and/or has some deemed control of it), and defeat the estate planning purpose of the strategy. Notably, the rule would only apply to the extent the economic interests overlapped - thus, for instance, if husband put $2M into a SLAT for wife, but wife put $5M into a SLAT for husband, only the $2M would be at risk for being uncrossed. Nonetheless, that still largely defeats the purpose of at least the husband funding a SLAT.As a result, in situations where there's a married couple, it's necessary to plan the structuring of SLATs around the potential for the reciprocal trust doctrine. As shown in the earlier example, in some situations there may not be a need or desire to create SLATs in both directions in the first place, such as where the husband is in very poor health and there is only be a desire to have the husband fund a SLAT before he dies (but the healthy wife doesn't need to fund a SLAT in reverse). Where there is a desire to create two SLATs, techniques to help keep them separate include: different trustees or co-trustees; different rights to the trust (e.g., one might have access to income, but the other only to principal); different beneficiaries (e.g., one might be for just the spouse, while the other might be for spouse and children); different powers (e.g., one might have a special Power-of-Attorney to change the distribution of assets to certain family members or charities); fund with substantively different assets (e.g., one trust gets cash and securities, and the other receives a share of the family business). Another strategy to avoid the rule is simply to space out the trusts in the first place; if one is created now, and the other isn't established until years from now, it's difficult for the IRS to claim they were purely reciprocal (although obviously the caveat is that waiting too long may diminish the benefit of the strategy, but that "risk" is part of what substantiates the trusts aren't reciprocal!).Unfortunately, the “reciprocal trust” doctrine is ultimately up to the judgment of a court, if challenged, which means there are no “safe harbor” rules to follow to guarantee the strategy will be safe. As a result, expect to see a lot of focus from the estate planning community in the coming years to figure out how to structure SLATs to most easily avoid reciprocal trust treatment, while being “as reciprocal as possible” to avoid or minimize any disruption on the client’s overall financial and estate planning goals.At some point in the coming years, states will likely close their state estate tax "loophole" - either by establishing a gift tax to backstop their estate tax exemption, creating a robust gift-in-contemplation-of-death rule to reduce at least the use of deathbed SLATs, recoupling to the Federal system to take advantage of the Federal gift tax system (including the IRS' enforcement of it), or just outright repealing their state estate tax. Until then, though, the SLAT remains a remarkably viable to manage or avoid state estate taxes while staying within the Federal gift and estate tax rules.