Retirement Planning for Divorced Individuals
Divorce can be one of life’s most challenging experiences. Not only is it distressing, but it also brings financial upheaval. And depending on your age, divorce may pose yet another risk: taking what was an on-track retirement plan squarely off balance.
For people in their 50s and up, the challenges are particularly acute. There will be less time to make up for what you will have lost. You will have a shorter timespan to gather earnings, put away savings, and accumulate more wealth from portfolio investment growth. Your goals and plan for retirement will also change, since you likely counted on a financial future with your partner.
Later-in-life breakups are a growing trend, as researchers at Bowling Green State University discovered. They found that, from 1990 to 2010, the divorce rate among couples in their 50s and beyond more than doubled. In that same period, the overall divorce rate remained relatively flat.
While it may be tempting to put finances on the back-burner, now isn’t optimal to fall back on planning ahead. Your financial security is at stake. If anything, it’s time to refocus on your financial progress and create a new plan for your personal retirement goals.
Here are some tips to help you get back into the driver’s seat of your money matters.
Taking Charge of Your Future
Yes, putting your life back together isn’t easy. But the good news is now you are in control of your future.
While divvying up retirement assets in a divorce might be a simple process, it requires that you do your homework, according to Mark Cussen, a financial writer and CFP®. Why? Because making the wrong move or failing to report asset transfers properly could result in serious tax consequences. In fact, some missteps may trigger more than a massive tax bill, and you may also end up paying a bundle in unncessary fees.
Many divorcing couples will have retirement plans. Just like other assets, they may be shared between both parties, although it’s possible that only one spouse will be awarded ownership.
Because there are rules governing asset division due to divorce, seeking guidance from retirement and legal experts at this stage can help you uncover what you must know about reporting and tax considerations. That way you aren’t left holding a tax bill that could have been avoided.
There are different rules for dealing with IRAs and qualified plans, which include both company pensions (defined-benefit plans) and employee plans like a 401(k) (defined-contribution plans).
Qualified plans come in many forms, so it’s important to know the major ones to be on the lookout for, including:
- Profit-sharing plans
- 403(b) plans
- 457 plans
- Target benefit plans
- Employee stock ownership (ESOP) plans
- Keogh (HR-10)
- Simplified Employee Pension (SEP)
- Savings Incentive Match Plan for Employees (SIMPLE)
Minding Your Ps and Q(DRO)s
Because qualified plans only allow certain types of instruments—most commonly publicly traded securities, mutual funds, money market funds, and real estate funds— they specify when and how distributions can be made.
Generally, employees must either the following in order to trigger allowable distributions:
- Reach the plan’s defined retirement age,
- Become disabled, or
- Pass away (in which case the beneficiary becomes the recipient).
However, there are important exceptions of which you will want to be aware.
Dividing an IRA is a process known as “transfer incident to divorce,” observes Jim Blankenship, a widely respected financial planner. Whereas qualified plans, such as a 401(k) and those listed above, are split under what’s called a Qualified Domestic Relations Order or (QDRO). While courts can confuse the two categories and consider them both as QDROs, you must correctly categorize each retirement asset submitted to your judge or mediator to represent them accurately in your divorce agreement. Failing to do this could cause delays or headaches during the proceedings.
IRAs are Treated Differently in Divorce
For example, when you specify that an IRA division is a “transfer incident to divorce,” there would be no tax assessed on the transaction, as Blankenship notes.
The IRA custodian could classify the distribution of funds as a transfer or a rollover. Either way, the person receiving the funds takes legal ownership after the transfer and assumes complete tax responsibility now and in the future for any distributions.
If you are the one losing the funds, you are released from any tax liability on what happens to them after your ex-spouse takes possession. You avoid owing tax on the assets because you followed the IRS rules for transfer incidents.
Here’s why you will want a professional’s help in handling this. If you did not adequately identify this division of assets, you could owe both tax and an early-withdrawal penalty on the money your ex-spouse received.
If third-party legal counsel is a necessity, consider looking for attorneys who know the ins-and-outs of QDROs.
Who Will Get Your Money?
After your joint assets have been divided, immediately update your beneficiary designations. If you owned a joint annuity or had designed an annuity income strategy to provide income payouts for your surviving (now ex) spouse, you will want to change those. Make sure all of your beneficiaries are updated.
Your ex-spouse is likely not to be a beneficiary unless your divorce decree specifies it. If you are splitting your ex’s pension, you may want to be sure you are listed as a survivor or beneficiary in order to keep collecting benefits once they pass.
Readjust Your Retirement Income Strategy, If Necessary
If you’re past your 50th birthday, the financial effects of divorce can be particularly hazardous. If you don’t have your own retirement income plan, now is the time to get your financial house in order. Should you have an income plan, start readjusting it with your retirement goals and objectives in mind. You should start by estimating your retirement spending needs and building annual forecasts of how much income you will need to cover them.
Be sure to carefully weigh any and all income sources you will have coming to you in retirement. Here are some key questions to start off your retirement income planning process:
- What income sources do you have?
- How long will your income sources last?
- What are their tax implications?
- When will you start drawing income from other sources beyond employment, or however you bring home your current income?
- For future monthly costs-of-living, do you have fixed income streams set?
- Or will you rely on income-generating sources with account balances that may vary depending on economic and market conditions?
- Does your income plan account for emergencies or situations that can be costly, like health emergencies or long-term care events?
- Does your income plan include calculations of inflation and its long-term effects on purchasing power?
Investigate Your New Social Security Options
While many people claim them early, Social Security benefits are likely to be a foundational part of your retirement income strategy. You may need to reconsider when and how you will begin taking your Social Security benefits once you are divorced.
Many people don’t realize that if they were married for 10 years (and meet other requirements), they can potentially collect on their ex’s Social Security benefits.
If you are entitled to benefits of your own, you may be allowed to receive the larger of your benefit or your share of your ex-spouse’s benefit payments. Since remarrying will affect your ability to collect based on your ex’s Social Security earnings record, it makes sense to weigh all your options as you make this important life decision.
Capitalize on the Newfound Freedom
You are your top priority now. This is a good time to revisit your life plan and see what your new financial priorities may be, including new steps to take to accomplish them.
If you’re not where you need to be with retirement savings, start committing yourself to better saving habits. Consider maximizing contributions to retirement plans and any retirement accounts. Under IRS rules, folks over age 50 can put away higher amounts of savings on a tax-deferred basis. You may want to explore the possibility of enhancing the tax efficiency of your retirement portfolio with your financial advisor, such as Roth conversions.
Should you seek other vehicles for retirement saving, annuities may be one of many instruments at your disposal. In an annuity contract, you can stash even more retirement dollars, let them grow tax-deferred, and then later tap that contract for future income purposes.
Be sure to consult with an experienced, annuity product-knowledgeable financial professional if you think this may be an option worth exploring.
Need Help with Getting Your Financial Life on the Right Track?
Successful retirement and income planning isn’t something that is done overnight. Rather, it takes time, attention to detail, and diligence to prepare for. If you believe that you could benefit from the guidance of a financial professional in achieving your retirement financial life goals, you can connect with one directly here at SafeMoney.com.
Use our “Find a Financial Professional” section to connect with someone directly. Should you need a personal referral, call us at 877.476.9723.
