Divorce and remarriage can have a big, and complicated, effect on your Social Security benefits.
So when "'til death do us part" doesn't work out as planned, people who are about to get divorced, especially women, might need a crash course on all things related to their retirement accounts and Social Security.
For starters, consider this: about four in 10 marriages eventually end in divorce and about a quarter of Americans age 65 and older are widowed. Despite those statistics, two-thirds of married individuals don't have a financial plan in place in the event of a divorce or becoming widowed, according to TD Ameritrade's Financial Challenges of Divorce & Widowhood survey of 2,000 adults ages 37 and older.
What's more, the TD Ameritrade survey found that seven in 10 men (72%) and six in 10 women (62%) are confident in their abilities to manage their own financial situation in the event of a divorce or a spouse passing away.
"Advance planning could provide a much-needed boost in financial security for those who unexpectedly end up alone at any phase of their lives," David Lynch, managing director and head of branches for TD Ameritrade, said in a release. "My professional guidance is for married individuals to ask themselves 'if I got divorced or lost my spouse, would I be prepared financially?'"
So how can you prepare financially?
Stash Some Cash
Before having the divorce conversation, Luana Mobley Corral, founder of Crossroads Consulting of South Florida, recommends stashing away some cash -- that will of course be disclosed in the divorce proceedings -- because divorce is a cash-hungry process.
"There will be attorney fees, therapist fees, fees for the financial advisor, or forensics, first, last and security deposit, new furniture, pots and pans, and the like," Corral said.
It is also good, she said, to repair the car, put on new tires, have needed dental work done, collect a few career wardrobe pieces all before the divorce talk. "And don't leave home without the paperwork," Corral said. "Complete an inventory of all the family assets and liabilities, get copies of statements and titles of everything you own and owe, as well as paystubs, and three years of tax returns."
Before the divorce talk, Corral also recommends that you learn as much about divorce as possible.
Women might consider attending a workshop, such as the Second Saturday Divorce Workshop.
The Mechanics of Money and Divorce
For women who are divorcing, there is much to consider regarding retirement accounts, said Bonnie Ashby Sewell, the founder of American Capital Planning and author of Love-Jacked! Divorce Your Spouse, Not Your Dollars. "We must look at the mechanics," she said "That includes the steps to ensure a smooth division and transfer post-divorce. Then there are the financial considerations for why a woman may prefer one account over another."
According to Sewell, there are three basic types of accounts to consider: Individual retirement arrangements (IRAs); 401(k) and similar employer-sponsored retirement plans including 403(b) and 457 plans; and traditional defined-benefit pension plans.
In some cases, a spouse might have to consider a fourth type of account, such as a deferred compensation plan. Those plans, typically held by high-income earners, can be a good source of retirement income, but the key is tax planning and understanding the rules of the deferred compensation plan.
"In general, we want the most efficient division available in any particular case," Sewell said.
Dividing IRAs in a Divorce
For example, if there are three IRAs and the husband owns two of them and the wife owns the third IRA, you would add up the dollar value of all three the accounts, divide by two and simply split one of the IRAs.
For example, let's say the husband has $100,000 in one IRA and $50,000 in another and the wife has $75,000 in her IRA. You would add the dollar value of all three accounts and divide that by two. ($225,000 / 2 = $112,500). You would then split either the husband's first or second IRA such that his wife would get $37,500 ($112,500 - 75,000 = 37,500) put into her IRA.
Of note, Sewell said, IRAs can be split by divorce decree; these accounts don't require a qualified domestic relations order (QDRO) to divide. A QDRO, according to the IRS, is a judgment, decree or order for a retirement plan to pay child support, alimony or marital property rights to a spouse, former spouse, child or other dependent of a participant. IRAs, Sewell noted, are easily split and both parties can invest as they wish after division without fear of capital gains because these are tax-deferred accounts.
Qualified Plans Require a QDRO
By contrast, a domestic relations order, according to the Labor Department, is a judgment, decree, or order (including the approval of a property settlement) that is made pursuant to state domestic relations law (including community property law) and that relates to the provision of child support, alimony payments, or marital property rights for the benefit of a spouse, former spouse, child, or other dependent of a participant. For more information, read IRS Publication 504, Divorced or Separated Individuals.
Sewell noted that any "qualified" plan governed by ERISA rules, such as a 401(k), must have a QDRO to divide it. "Qualified" because it's an ERISA plan; "domestic relations" because this is a divorce division; and "order" because that is what's needed to force the division, said Sewell. "The marital share is usually the beginning balance at the start of the marriage up to the date of separation," she noted.
With 401(k) plans, you would follow same procedure -- noting of course the need for a QDRO -- you did for splitting IRAs.
Qualified employer-sponsored retirement plans such as a 401(k) have a special feature for divorcees. "The parties can pull cash from the account to the other party as an alternate payee at the time of transfer that is part of the divorce division," Sewell said. "From there they must include the amount not rolled over into another plan as income that year. However, they do avoid the 10% early withdrawal penalty."
This, Sewell said, can be an essential tool in paying out home equity, paying off debt, or simply easing cash flow during this tough time.
Traditional defined-benefit pensions also require a QDRO to divide. "There is a fancy term here, 'coverture fraction' which determines the marital share to be split," Sewell said. According to Duhaime's Law Dictionary, the coverture formula is a method of proportionate division of a spouse's pension benefits as accrued during the period of marriage.
For her part, Corral suggests learning how qualified plans can be divided before reaching your agreement. "Plan rules rule and the plan won't do what the plan does not allow, even if you have agreed to it," she said.
Corral also recommends getting your QDROs signed by the judge at the final hearing along with the final judgment.
When it comes to dividing a pension, however, Sewell noted that these benefits "are valuable because the benefit will come regardless of market returns." There is, however, risk if the pensioner dies and there is no survivor benefit. Her advice: Insure the survivor benefit using term life insurance or directly through the pension program if it is offered.
Sewell also noted that pensions can be viewed as both an asset (there's a dollar value assigned to the present value of the benefit, of the stream of income) and as income to the recipient.
As for splitting assets held in taxable accounts, earmarked for retirement or not, Corral suggests learning in advance the tax consequences of the assets you accept in the equitable distribution. Also learn how or if your annuity contracts can be divided.
Social Security and Divorce
A person will be eligible for an ex-spouse benefit at age 62 if the marriage lasted 10 or more years and she or he is single when they apply for it, according to Karen Mathias, an attorney with Lange Accounting Group.
For example, the ex-husband, she noted, must be at least 62 years old and doesn't have to have applied for his benefits if the divorce occurred two or more years before the wife applied.
According to Mathias, the amount of the ex-spouse benefit is the same as the spouse benefit: 50% of the ex-husband's primary insurance amount (the amount he would get if he collected at full retirement age), if she begins collecting at her full retirement age. If she collects between 62 and full retirement age, the percentage will be reduced (ranges from 35% at 62 to 45.8% at 65).
Also of note, Mathias said the ex-spouse would be eligible for survivor benefits.
Mathias also noted that future Social Security benefits are not subject to division under community property settlements, equitable distribution settlements or other divisions of property.
Corral noted that if you are married close to 10 years, consider delaying the final hearing until after your 10th anniversary to preserve the divorced spouse Social Security benefit.
One other warning. "Should you ever remarry, and you were intending to make use of that one-half benefit, you lose it," said Sewell. "So, you'll want to consider getting the lifetime value of that benefit protected through a prenuptial agreement. Your subsequent marriage must last 10 years to have the next spousal benefit available to you."
Keep in mind the loss of survivor benefits if considering remarriage before age 60, said Mathias.
In Sewell's practice, when working with couples going through a divorce, she asks to see all four pages of each spouse's Social Security statement because this provides a lifetime income history. Of note, the Social Security Administration currently mails Social Security Statements to workers age 60 and over who aren't receiving Social Security benefits and do not yet have a "my Social Security" account. Read more information about getting your Social Security statement.
Mathias also said Social Security benefits can be considered in determining alimony. "For instance, the ex-spouse's benefits can be equalized by determining the difference between their benefits and adding half of that amount to the amount the ex-husband would otherwise pay in alimony and he gets an adjustment to income for it, for income-tax purposes."
Women going through a divorce might consider the possibility of their spousal or survivor's Social Security benefits declining in the years to come, said Sewell. "Social Security is an important safety net for many families and the program bears watching, as it will struggle to pay full benefits in 2034 and beyond which is only 16 years in the future," she said.
For many women, Social Security benefits are a critical source of income in retirement, said Mathias. "When a marriage ends, it isn't necessarily the end of entitlement to benefits based on the ex-husband's work record," she said. "This is a very complex and fact-specific area, and one worth evaluating carefully before a life-changing financial mistake is made."
More Planning Tips
- Do not sign a settlement agreement that has not been modeled by an experienced divorce financial planner (DFP).
- When you start divorce negotiations, you should engage a DFP so that you know your money and have context for negotiation.
- Whenever possible, the marital estate and income should result in two financially stable households post-divorce. "When that does not occur and there was enough to make it occur, it means the rest of us -- society -- must pick up the tab as the financially stressed spouse ages," Sewell said, "Fundamentally, this is unfair to many more people beyond the stressed spouse."
- Tax reform could bring changes to alimony which would make retirement accounts even more important.
- Don't forget life insurance and disability insurance to protect alimony and child support.
Got questions about money, write to Robert.Powell@TheStreet.com
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