I will be divorced at 55 with $800,000 in my 401(k). How can I protect my finances?

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Like all family and property law, divorce is a very state-specific process. How you will handle a divorce and protect your assets, as well as what constitutes individual assets vs. shared assets, will depend entirely on your jurisdiction. As a result, how retirement accounts are treated during divorce proceeds can vary greatly from state to state.

If you need financial advice during or after a divorce, consider contacting a fiduciary financial advisor today.

The first step is usually the separation of personal and marital assets. In most cases, you keep assets and debts that were before the marriage and divide the assets and debts that you acquired while you were married. This is much more complicated than it sounds, as it is very easy for assets to combine and divide the value accumulated during the marriage.

For example, say you’re 55 and have $800,000 in a 401(k). The most important part of this will be where you live and how much of the account was earned during the marriage. From there, a divorce court will typically divide the 401(k) based on your overall household assets and, in particular, any other retirement accounts owned by you or your spouse.

Although a full discussion of this issue is far beyond the scope of a single article, we will explore some of the most important factors to consider below.

Retirement accounts and divorce

Divorce courts typically do not grant special status to a couple’s tax-advantaged retirement accounts. A judge will treat these portfolios as a standard financial asset, dividing each account based on the overall distribution of assets, the relative financial status of the parties, and the marital status of the account versus personal status, among other factors.

There is no tax penalty for taking early withdrawals to transfer retirement assets between divorcing spouses. This is usually done through a “Qualified Domestic Relations Order” or a “Divorce Transfer Incident” depending on the nature of the account.

You can move these funds directly to another eligible account before taxes without triggering income taxes or an early withdrawal penalty.

For example, say you have $800,000 in a 401(k), of which you had $300,000 in the account when you got married. Typically, you will keep the $300,000. The remaining $500,000 could be considered marital property and can be divided between you and your spouse. Then you could agree to split that money 50/50 and draft a QDRO to remove $250,000 worth of assets from the 401(k) and move them into an account of your spouse’s choosing.

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Retirement accounts can be distributed directly, with one spouse receiving the assets or their cash equivalent at the time of divorce. Assets can also be divided upon retirement, with each spouse taking income or distributions according to the terms of the divorce. This is most common with a more structured retirement asset, such as an annuity or pension, which can be difficult to divide.

Whether you’re just starting divorce proceedings or have completed them, a financial advisor can help you set and plan for new financial goals with this major life change in mind.

Community vs. Equity States

There are two main ways states deal with divorce assets: community or equity.

Community ownership has become increasingly disfavored, so relatively few states (nine total) still practice it. Under this scheme, a court will order the marital assets to be divided equally between the spouses upon divorce, with each spouse taking half. Here, for example, under a community property scheme, a court would simply award each spouse 50% of the marital component of the 401(k).

Equity, or “fair distribution,” is increasingly the standard model. Under this approach, courts will try to distribute divorce assets fairly, not necessarily equally. The court will consider several factors, including (but not limited to) the length of the marriage, child custody arrangements, work and career, financial and personal contributions to the marriage, earning potential and, in some cases, mistakes and wrongdoing .

In the case of a pension fund, a court might also consider matters such as the age of the spouses (who has more time to save), each spouse’s future Social Security benefits, and other retirement assets owned by each spouse. For example, if you are 55 and your spouse is 45, the court may give you more of the 401(k) assets because you have less time left until retirement. On the other hand, if you have $800,000 in your 401(k) and your spouse has $750,000 in theirs, a court could transfer few (if any) assets between two similarly situated parties.

Whether you live in community property or an equitable distribution state, a financial advisor can help you consolidate the assets you receive from a divorce and build a comprehensive financial plan around them.

Protection of assets and fiscal status

The truth is, there are few legitimate ways to protect your marital assets from divorce proceedings. Many tips on this topic shade into illegality, as trying to hide your assets or their marital history can constitute fraud. As a result, most advice to move your assets or change their tax status is useless at best, legally suspect at worst.

Some advice recommends that you stop contributing to a 401(k) during the divorce proceedings. While this will (modestly) reduce the earnings your spouse can claim, it will equivalently reduce your own earnings and not change the underlying cash distribution.

While a financial advisor can be a valuable resource during a divorce, there are some basic steps you can take:

1. Set up your own bank accounts

First, once the divorce begins, establish your own bank accounts. Cash flow will be critical. You’ll need to pay legal bills, establish your own household, start building a separate credit history, and more. You may also want to buy your spouse out of his or her share of the retirement portfolio. For example, say you have an $800,000 401(k) based on stock options from your employer. You may want to keep those assets invested. In that case, you may want to build up cash so you can pay your spouse the equivalent of his 401(k) share by trading the cash for more valuable portfolio assets.

Although your spouse may choose to decline your offer if he also prefers long-term value assets.

2. Prevent Your Spouse From Cashing Out Your 401(k)

You’ll also want to talk to your divorce attorney and your 401(k) plan administrator right away. It is not unusual in divorce proceedings for spouses to try to sell, move or spend assets. In some cases, this is an effort to disrupt proceedings, for example by converting identifiable securities into obscure personal property. In other cases, it is simply an attempt to destroy or devalue shared assets out of spite.

Whatever the goal, you want to address this early. It is much easier to prevent your spouse from cashing in your 401(k) than it is to try to get the money back.

3. Collect and create explicit records

You want to know exactly what you own and where. Clearly document any financial transactions you make and pay attention to any transactions made by your spouse. This documentation includes addressing beneficiaries on all policies, such as 401(k) and life insurance. You do not want your spouse to retain authority or rights under these accounts, regardless of how they are divided.

4. Pay attention to the tax status of the assets

Finally, pay attention to the tax status of your settled assets. For example, say you have an $800,000 Roth IRA in addition to your $800,000 401(k). Don’t accept a divorce settlement that treats those as assets of equal value, because the Roth account is likely worth much more than the other. Make sure you and your attorney insist that you treat your 401(k) as a pre-tax asset, and not the $800,000 asset it appears to be.

Conclusion

Protecting your assets during a divorce is difficult because as far as the law is concerned, they are not your assets. They belong equally to your husband. But you can put yourself in a better position by remembering to track your money and evaluating it for its long-term, after-tax value.

Financial advice for divorce

• Getting a divorce is stressful and painful, especially since it involves some of the most complex financial transactions any household can undertake. While it’s important to have legal and financial professionals to help you through the process, you should also understand exactly what’s going on.

• Finding a financial advisor doesn’t have to be difficult. The free SmartAsset tool matches you with up to three verified financial advisors serving your area, and you can have a free introductory call with your matched advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help reach your financial goals, get started now.

• Keep an emergency fund handy in case you face unexpected expenses. An emergency fund should be liquid — in an account that isn’t exposed to significant fluctuations, such as the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But a high interest account allows you to earn compound interest. Compare savings accounts from these banks.

• Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with prospects and provides marketing automation solutions so you can spend more time converting. Learn more about SmartAsset AMP.

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