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Tuesday, August 6, 2019

When Dividing Retirement Accounts in Divorce the Division Date Matters

There are a number of questions that must be answered when dividing a retirement account in a divorce.  Divorcing couples are often focused specifically on the amount or percentage of the account funds that they are dividing.  It is also important, though, to identify the date of that division, and whether investment changes are included or not.  This information is necessary because dividing a retirement account is not as immediate as dividing a liquid asset.

Dividing a retirement account in divorce requires a special court order (usually called a Qualified Domestic Relations Order or QDRO).  The process of obtaining and implementing one of these orders is not immediate, and requires approval by both the court and the plan's administrator.  During this time, the account will change value.  Accounts change in value due to market fluctuations, but also due to withdrawals, loans, and ongoing contributions.  All of these changes can create havoc with a division if a clear date of division is not identified.

Consider just this simple division example:

Pat and Chris agree to divide Pat's 401(k) with Chris receiving 50%.

They don't specify the date of division, but they sign their agreement on January 2, 2019.  Due to the divorce process timelines in Massachusetts their hearing date on a Joint Petition for Divorce is February 4, 2019.  Their Judgment of Divorce Nisi issues on March 6, 2019, and becomes final on June 4, 2019 (their legal divorce date).  They just hired their QDRO drafter (on April 1, 2019) and estimate that the time from starting their QDRO drafting to having it implemented will be approximately 4 months (for drafting, pre-approval, court approval, final approval, and implementation), with an estimated transfer of funds on August 1, 2019.

The following are the changing values in the 401(k)

January 2, 2019: $400,000
February 4, 2019: $410,000 (from 1/2/19 contributions of $1,000, approx. investment gain of $9,000)
March 6, 2019: $425,000 (from 1/2/19 contributions of $2,000, approx. investment gain of $23,000)
June 4, 2019: $436,000 (from 1/2/19 contributions of $10,000, approx. investment gain of $26,000)
August 1, 2019: $438,000 (from 1/2/19 contributions of $14,000, approx. investment gain of $24,000)

Pat has continued to contribute to the account, and investments caused a surge in the Spring, but there have been some losses in investments in July.  Now consider the different resulting distribution of funds on August 1, 2019 depending on which date of division is chosen:

Date of Valuation Including Investment Changes Excluding Investment Changes
Pat Retains Chris Receives Pat Retains Chris Receives
Date of Agreement (January 2, 2019) $226,000 $212,000 $238,000 $200,000
Date of Hearing (February 4, 2019) $225,500 $212,500 $233,000 $205,000
Judgment of Divorce Nisi (March 6, 2019) $226,000 $213,000 $225,500 $212,500
Judgment of Divorce Absolute (June 4, 2019) $221,000 $217,000 $220,000 $218,000
Date of Transfer (August 1, 2019) $219,000 $219,000 $219,000 $219,000


*For demonstration purposes I've used round numbers, but there would be some additional differences due to the investment gains or losses on the contributions made between January 1, 2019 and August 1, 2019, and that would change these figures slightly as well.

In this example, Chris receives more of the account if all the contributions are included (a later date of distribution), and in most cases a greater resulting amount if investment gains are included as well (except when using June 4, 2019 because of the dip in investment values in July).  A later date of valuation is obviously better for Chris, but is it fair?

Pat may not feel it is fair to share the contributions after a certain time period, and the risk only increases to Pat if the QDRO process is delayed for any reason and the transfer date becomes later than August 1, 2019.  What is fair is always subjective, and one of the benefits of a set valuation date (regardless of which date) is that it gets ride of any motivation by Chris to delay the QDRO process.  

When sharing investment gains, Pat and Chris share the same risk and benefit of an increasing or decreasing market and for these reasons most divorcing couples choose to share the investment gains and losses, and to set as specific date of valuation.  While there may be reasons in some cases to vary from what is typical, it is important that everyone  understand these risks and benefits so they can make an informed decision.  

As QDRO preparation experts and consultants the staff at Gray Jay Endeavors, LLC wants their customers to provide clear direction for the drafting of the QDRO, preferably in their divorce agreement itself, so there is no chance for later disagreement if the market changes or the QDRO is delayed due to unforeseen circumstances. Many experts, like Gray Jay, will also assist in reviewing or drafting Agreement provisions related to retirement to ensure that all these issues are addressed.

Guest Post from Gray Jay Endeavors, LLC







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