Avoiding Mistakes with 401(k) Distribution in a Divorce

Avoiding Mistakes with 401(k) Distribution in a Divorce

By: M. Scott Gordon

Anyone who is planning to get divorced in Chicago and has a 401(k) or another type of retirement account should know that these accounts are considered marital assets (under many circumstances) and are subject to division under the Illinois Marriage and Dissolution of Marriage Act (IMDMA). Given that the IMDMA requires all marital property to be divided in a manner that is equitable to both parties, property division frequently means that 401(k) accounts must be distributed in a divorce. The longer a couple has been married, the more complicated it can be to divide a 401(k) and other retirement accounts.

We want to discuss mistakes to avoid with 401(k) distribution in a Chicago divorce. Mistakes can range from assuming that all of the 401(k) funds will be classified as marital assets, to forgetting about the terms of a premarital agreement, to spending down the 401(k) prior to a divorce without considering the tax consequences.

1. Do Not Assume That All of the 401(k) Account is a Marital Asset

If you have been paying into a 401(k) account for many years—including the years prior to your marriage—you should know that the entire 401(k) likely is not marital property. Certainly, a portion of the 401(k) will be considered a marital asset, but a percentage of the account might in fact be separate (or nonmarital) property that is not subject to division. Typically, marital property is anything that a person acquired after the marriage, and non-marital or separate property includes assets acquired before the marriage or through a gift or inheritance given only to one spouse.

Although it may be difficult to determine, a portion of a 401(k) may be classified as non-marital property and can be taken out of the equation when it comes to distributing marital property.

2. Do Not Forget About Premarital Agreement Terms

Some spouses enter into premarital agreements concerning asset division in the event of divorce. Premarital agreements in Illinois can contain terms about 401(k) accounts and other retirement assets. If there is a premarital agreement that is enforceable, it is important to know whether it contains terms concerning retirement accounts.

3. Do Not Assume That Early Withdrawals Are in Your Best Interest

When couples are thinking about divorce but have not yet filed, one or both of the spouses might think it makes sense to spend down a 401(k) in order to prevent it from being distributed in the divorce. However, spending down the account could cost you much more in the long run when it comes to the federal tax penalty.

If you are under the age of 59 ½ years, you should keep in mind that most withdrawals from a 401(k) account will be subject to a 10 percent federal tax penalty (in additional to regular income tax). There are some situations in which this 10 percent tax penalty can be waived, but it may hurt you more financially to spend down your 401(k) prior to the divorce instead of having the retirement funds distributed.

Contact a Dedicated Divorce Lawyer in Chicago

The distribution of marital property can be extremely complicated, especially when high net worth or complex assets are involved. A dedicated divorce attorney in Chicago can assist with your case. Contact Gordon & Perlut, LLC for more information about how we can help with your divorce and the division of marital property.