By: Joseph Goldy, CFP®
The Rise of Gray Divorce
When going through a divorce, many challenging topics need to be talked through before things become finalized. When it is time to discuss marital assets, particularly among those 50 and older, retirement assets or pension benefits tend to be at the top of the list since they often have the most significant balances. As seen on the graphic from Pew Research below, so-called gray divorce, or divorce among those 50 and over, is on the rise despite divorce rates generally declining.
The qualified accounts of this age group tend to be larger due to a longer period of contributing than younger divorcees. Pensions, 401(k)s, 403(b)s, and other qualified accounts need to be divided, but they have special rules that prevent someone from simply making withdrawals as you would with a regular brokerage or bank account.
Further, qualified accounts are designed to be in just an individual’s name, not held jointly, and are provided unique tax benefits. Because of this, splitting qualified retirement accounts correctly in a divorce is critical to avoid running afoul of IRS rules and inadvertently triggering a large tax bill.
What is a Qualified Domestic Relations Oder (QDRO)?
A Qualified Domestic Relations Order is a decree or court order that outlines how “Participant” assets are to be split with another person, the “Alternate Payee.” The QDRO is essentially a legal roadmap that will allow a qualified retirement plan to be divided without incurring the standard 10% IRS penalty if drafted and followed correctly.
The receiving party (Alternate Payee) will also avoid any tax liability, assuming they deposit the received funds into another retirement plan. If they decide not to roll the funds into another tax-sheltered account, they will pay taxes on the amount received.
Interestingly, Qualified Domestic Relations Orders do not start as “Qualified.” That comes after a Domestic Relations Order is drafted by an attorney and then sent to a retirement plan administrator who reviews it to ensure ERISA and IRS requirements are met and then signs off that it is qualified.
The Benefit of Using a QDRO
QDROs play a vital role in a divorce since qualified retirement plans cannot be assigned to another person under standard ERISA protections. This provision for retirement plans is helpful since they provide creditor protection for plan assets and give peace of mind to the Participant that their nest egg is secure should they get sued or file for bankruptcy. Since a divorce must assign plan assets to another person, a QDRO facilitates this transfer.
How is a QDRO Paid?
There are two main ways a Qualified Domestic Relations Order will be paid out:\
The “Shared Payment” method
The “Separate Interest” method
Shared Payment Method
The Shared Payment method is when an Alternate Payee begins receiving their “share” of the benefit only once the Participant has decided to start taking their payments from the plan. From a planning perspective, the downside is the Alternate Payee is reliant on when their ex-spouse chooses to begin taking their pension payouts.
Planning becomes difficult to model since the recipient doesn’t know when or if benefits may begin. Depending on how the QDRO is drafted, the recipient may never receive the expected benefits if their ex-spouse predeceases them and does not select a joint annuity pension payment option.
Notably, it is common for the Shared Payment to be used with a gray divorce since pension benefits are already being paid due to the age of the divorcing parties. In these situations, it is too late to split interest in a pension, so the Shared Payment method is utilized.
Separate Interest Method
The Separate Interest method of a QDRO provides an alternative. With the Separate Interest payout, both the Participant and the Alternate Payee are given their account share. This payout type lets both parties know how much of their benefit amount will accrue and control when to begin receiving their benefits. The Alternate Payee is no longer reliant on the Participant’s decisions, providing more clarity for planning.
The Participant may resist a Separate Interest QDRO since they will not see an increase in their payments should something happen to the Alternate Payee before receiving their benefits. In contrast, with the Shared Payment option, should the Alternate Payee predecease the Participant, they would receive an increase in the payment of their benefits due to the Alternate Payee’s share reverting to the Participant, thus increasing the pension payment amount.
Getting a divorce is difficult at any age. Yet, for older Americans who experience a gray divorce, QDROs are very likely going to be a part of your marital settlement agreement. Making sure your financial planner is kept informed as you go through a divorce is critical to ensure you know how a QDRO will impact your goals and long-term life plans.
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.