Going through a divorce can be a challenging time for anyone, and when retirement accounts are part of the marital assets, it adds an extra layer of complexity. Dividing assets like 401(k)s, IRAs, and pensions during a divorce can significantly impact your financial future. It’s essential to understand how Illinois law treats retirement accounts in a divorce, and how you can ensure you receive your fair share.
In this comprehensive guide, we will discuss how the courts divide retirement accounts in Illinois divorce cases, the role of Qualified Domestic Relations Orders (QDROs), and the tax implications of dividing these important assets. Additionally, we’ll answer common questions to give you a clearer understanding of the process.
Related Article: Navigating the Division of Retirement Accounts in High Asset Divorce
Types of Retirement Accounts in Divorce
Each type of retirement account comes with its own set of rules and legal requirements when it comes to asset division in a divorce. Below, we will break down the most common types of retirement accounts and how Illinois courts typically handle them.
401(k) Accounts
A 401(k) is a tax-advantaged retirement savings plan offered by many employers. These accounts are commonly called “defined contribution plans” as you know each month what you are contributing towards your retirement in these accounts. In a divorce, the portion of the 401(k) that is accumulated during the marriage is called the marital portion and is considered marital property. Marital property is subject to equitable division in a divorce.
A document called a Qualified Domestic Relations Order (QDRO) is the crucial document in dividing a 401(k). This order allows the retirement plan administrator to distribute a portion of the account to the non-earning spouse without either party incurring penalties or taxes. After the QDRO is approved by the plan and entered by the court, the non-earning spouse’s share of the 401(k) gets rolled over into an IRA account in their own individual name. The non-earning spouse can then decide to keep the funds in that IRA, roll-over the IRA funds into a different IRA, invest the funds in other ways (which could have tax consequences), or they can opt for a cash distribution (which may have tax consequences if taken early).
IRA Accounts (Traditional and Roth IRAs)
An Individual Retirement Account (IRA) is another common retirement vehicle. Unlike a 401(k), a QDRO is not usually required to divide an IRA in a divorce. Instead, the account can be divided through a transfer incident to divorce, which allows the funds to be transferred without tax penalties. This transfer can be completed by filling out transfer forms with the IRA so that the funds being transferred to the non-earning spouse can be put into a separate IRA in their own individual name. Just like with a 401(k) plan, the funds that get divided in a divorce are any funds that were accumulated during the marriage, or the marital portion.
It’s important to note that if either spouse withdraws funds from the IRA rather than transferring them to a new account, they could face taxes and penalties, particularly if they are under the age of 59 ½. Both Traditional IRAs and Roth IRAs can be divided, but they have different tax implications if you withdraw funds.
Pensions
Pensions can be complex assets to divide because they involve future payouts rather than a present-day balance like a 401(k) or an IRA. Pension benefits are commonly called “defined benefit plans”. The non-earning spouse will get a monthly payment from the pension plan, but won’t know the total benefits they will receive until their spouse retires an. Illinois law considers the portion of the pension earned during the marriage marital property. The marital portion of the pension is subject to equitable division.
A QDRO (or similar legal order) divides pensions and ensures the non-earning spouse receives a percentage of the pension benefits upon the pension-holder’s retirement. Special rules apply to military pensions and government pensions, making it even more important to have an experienced attorney guide you through the process. For a more detailed breakdown of pensions, visit our blog on Pension Division in Divorce.
Other Retirement Accounts
Some other retirement accounts that may be involved in divorce cases include:
- 403(b) accounts (for public employees)
- Thrift Savings Plans (TSPs) (for federal employees)
- SEP IRAs (Simplified Employee Pensions)
Each of these accounts has unique rules for division and may or may not require a QDRO, depending on the type of account and the institution managing it.
Illinois Law and the Division of Retirement Accounts
Illinois uses an equitable distribution model to divide assets, including retirement accounts. This approach ensures a fair, though not always equal, division of marital property. When dividing assets, the court evaluates several factors:
- The length of the marriage
- Each spouse’s financial contributions to the marriage, including non-financial contributions like raising children or managing the household
- The current financial situation and earning potential of each spouse
- The needs of each spouse, particularly in the case of ongoing financial support
- Each spouses’ non-marital assets
The court only divides the marital portion of a retirement account, which includes contributions made during the marriage. Contributions made before the marriage or after signing a legal separation agreement remain non-marital property and stay with the original account holder.
Download our ‘Guide to Property and marital Assets Division
Understanding QDROs and Why They Matter
A Qualified Domestic Relations Order (QDRO) divides employer-sponsored retirement accounts like 401(k)s and pensions without penalties. This legal document directs the retirement plan administrator to transfer part of the account to the non-earning spouse.
Submitting a QDRO to the court and then sending it to the plan administrator ensures each spouse receives their share of retirement benefits, while protecting the plan from early withdrawal penalties. Some accounts, like IRAs, don’t require a QDRO; instead, you can divide these through a “transfer incident to divorce” by completing specific forms.
Drafting or submitting a QDRO with errors can lead to costly delays or financial losses. So, you should work with an experienced divorce attorney to handle the process correctly. Each QDRO must use specific language tailored to the plan administrator’s requirements. Ask your divorce attorney for a sample QDRO to get start the process. You may also consider retaining an attorney who specializes in retirement division to draft the document and prevent approval delays.
Tax Implications of Dividing Retirement Accounts
Improper handling of retirement account division in divorce can create significant tax consequences. Here’s what to consider:
- 401(k)s and Pensions: A QDRO allows tax-free transfers. However, if the non-earning spouse takes a lump sum instead of rolling funds into another retirement account, they will owe income taxes. Withdrawals before age 59 ½ may also trigger early withdrawal penalties.
- IRA Accounts: A transfer incident to divorce remains tax-free as long as you roll the funds into a new IRA or retirement account. However, cashing out funds can result in taxes and penalties.
- Roth IRAs: Roth IRA withdrawals are typically tax-free in retirement since contributions are after-tax. But withdrawing funds before reaching age 59 ½ could lead to penalties.
Protecting Your Financial Future
Dividing retirement accounts in a divorce can significantly impact your financial future. Understand your rights and work with knowledgeable legal and financial professionals. This approach helps protect your assets during the process.
If you need assistance dividing retirement assets during divorce, contact Anderson Boback & Marshall. Our attorneys have extensive experience with complex divorce cases involving retirement accounts, pensions, and other critical assets.
