Gray Divorce: Dividing Assets Can Impact Retirement
Although most people who marry hope their unions will last forever, about 50% of first marriages in the United States end in divorce.1 Individuals age 50 and older are still less likely to get divorced than those who are younger. Even so, the divorce rate for Americans under age 40 has declined since 1990, while it has roughly doubled for those age 50 and older.2
Unfortunately, a divorcing couple must typically negotiate a property settlement agreement (or seek the assistance of the courts) to divide assets. Retirement plan benefits are often among the most valuable marital assets to be divided, along with houses, cars, and bank accounts. The laws of your particular state will define which retirement benefits are marital assets (or community property in community property states) that are subject to division.
Trading marital assets
You and your spouse may have one or more retirement accounts held by various financial institutions, or pension benefits from past and current employers. In some cases, one spouse may agree to waive any rights to all or some of the other spouse’s retirement benefits in exchange for other marital assets (for example, a home).
With 401(k) plans or IRAs where the value is clear, trading the account balance for other marital assets is generally straightforward. On the other hand, trading pension benefits should be done only if you’re certain the present value of those future payments has been accurately determined. Before you give up a valuable lifetime income, make sure you’ll have other adequate resources available to you at retirement.
If assets in a qualified retirement plan will be divided, a qualified domestic relations order (QDRO) is provided to the employer. Pursuant to a QDRO, one spouse could be awarded all or part of the other spouse’s pension plan benefit or 401(k) account balance as of a certain date.
Be sure to consult an attorney who has experience negotiating and drafting QDROs, especially if the QDRO may need to address complex issues such as survivor benefits, benefits earned after the divorce, plan subsidies, and cost-of-living adjustments (COLAs), among others. (For example, a QDRO may state that a first wife is to be treated as the surviving spouse, even if the husband remarries.)
Assuming the transfer is done correctly, the recipient is responsible for any taxes on benefits awarded pursuant to a QDRO. If the distribution is taken from the plan, the 10% penalty that normally applies to early distributions before age 59½ will not apply. The recipient may be able to roll certain distributions into an IRA to defer taxes.
IRAs and taxes
Dividing assets in IRAs or nonqualified plans does not require a QDRO. However, a divorce decree may be needed to avoid the negative tax consequences of IRA distributions resulting from divorce. If the IRA assets are transferred to the former spouse’s IRA in accordance with a divorce decree, then the original IRA owner will not be responsible for any taxes on the distribution. Going forward, the recipient spouse must pay ordinary income tax when distributions are taken from the IRA.
IRAs may play another important role in negotiations now that the tax deduction for alimony payments has been eliminated for divorce agreements executed after December 31, 2018. When a recipient spouse is older than 59½ (or doesn’t need immediate spousal support), it might make sense to offer a lump-sum payment of alimony from a traditional IRA instead of making after-tax payments going forward.
1 National Survey of Family Growth, Centers for Disease Control and Prevention, 2017
2 Pew Research Center, 2017
Reviewing Your Estate Plan
An estate plan is a map that explains how you want your personal and financial affairs to be handled in the event of your incapacity or death. Due to its importance and because circumstances change over time, you should periodically review your estate plan and update it as needed.
When should you review your estate plan?
Reviewing your estate plan will alert you to any changes that need to be addressed. For example, you may need to make changes to your plan to ensure it meets all of your goals, or when an executor, trustee, or guardian can no longer serve in that capacity. Although there’s no hard-and-fast rule about when you should review your estate plan, you’ll probably want to do a quick review each year, because changes in the economy and in the tax code often occur on a yearly basis. Every five years, do a more thorough review.
You should also review your estate plan immediately after a major life event or change in your circumstances. Events that should trigger a review include:
- There has been a change in your marital status (many states have laws that revoke part or all of your will if you marry or get divorced) or that of your children or grandchildren.
- There has been an addition to your family through birth, adoption, or marriage (stepchildren).
- Your spouse or a family member has died, has become ill, or is incapacitated.
- Your spouse, your parents, or another family member has become dependent on you.
- There has been a substantial change in the value of your assets or in your plans for their use.
- You have received a sizable inheritance or gift.
- Your income level or requirements have changed.
- You are retiring.
- You have made (or are considering making) a change to any part of your estate plan.
Some things to review
Here are some things to consider while doing a periodic review of your estate plan:
- Who are your family members and friends? What is your relationship with them? What are their circumstances in life? Do any have special needs?
- Do you have a valid will? Does it reflect your current goals and objectives about who receives what after you die? Is your choice of an executor or a guardian for your minor children still appropriate?
- In the event you become incapacitated, do you have a living will, durable power of attorney for health care, or Do Not Resuscitate order to manage medical decisions?
- In the event you become incapacitated, do you have a living trust or durable power of attorney to manage your property?
- What property do you own and how is it titled (e.g., outright or jointly with right of survivorship)? Property owned jointly with right of survivorship passes automatically to the surviving owner(s) at your death.
- Have you reviewed your beneficiary designations for your retirement plans and life insurance policies? These types of property pass automatically to the designated beneficiaries at your death.
- Do you have any trusts, living or testamentary? Property held in trust passes to beneficiaries according to the terms of the trust. There are up-front costs and often ongoing expenses associated with the creation and maintenance of trusts.
- Do you plan to make any lifetime gifts to family members or friends?
- Do you have any plans for charitable gifts or bequests?
- If you own or co-own a business, have provisions been made to transfer your business interest? Is there a buy-sell agreement with adequate funding? Would lifetime gifts be appropriate?
- Do you own sufficient life insurance to meet your needs at death? Have those needs been evaluated?
- Have you considered the impact of gift, estate, generation-skipping, and income taxes, both federal and state?
This is just a brief overview of some ideas for a periodic review of your estate plan. Each person’s situation is unique. An estate planning attorney may be able to assist you with this process.
Business Owners: What's Your Plan for Retirement?
If you’re a small-business owner, you probably pour your heart, soul, and nearly all your money into your business. When it comes to retirement planning, do you cross your fingers and hope your business will provide the nest egg you’ll need to live comfortably? What if you become ill and have to sell your business early? Or what if the business experiences setbacks just before you retire?
Rather than relying on your business to define your retirement lifestyle, consider a tax-advantaged retirement plan to supplement your strategy. Employer-sponsored plans offer many benefits, including current tax deductions for the business itself and tax-deferred growth (and perhaps even tax-free income) for you and your employees. Here are some options to consider.
Although these types of plans generally have regulatory requirements that can be costly and somewhat cumbersome, they offer a certain level of control and flexibility.
- Profit-sharing plan: Typically, only the business contributes to a profit-sharing plan. Contributions are discretionary (although they must be “substantial and recurring”) and are placed into separate accounts for each employee according to an established allocation formula. There’s no fixed amount requirement, and in years when profitability is particularly tight, you generally need not contribute at all.
- 401(k) plan: Perhaps the most popular type of retirement plan offered by employers, a 401(k) plan can allow employees to make both pre- and after-tax (Roth) contributions. The accounts grow on a tax-deferred basis. Distributions from pre-tax accounts are taxed as ordinary income, whereas distributions from Roth accounts are tax-free as long as they are qualified. Employee contributions cannot exceed $18,500 in 2018 ($24,500 for those 50 and older) or 100% of compensation, and you, as the employer, can choose to match a portion of employee contributions. These plans must pass tests to ensure they are nondiscriminatory; however, you can avoid the testing requirements by adopting a “safe harbor” provision that requires a set matching contribution based on one of two formulas. Another way to avoid testing is by adopting a SIMPLE 401(k) plan. However, because they are more complicated than SIMPLE IRAs (described later in this article), SIMPLE 401(k)s are not widely utilized.
- Defined benefit (DB) plan: Commonly known as a traditional pension plan, DB plans are not as popular as they once were and are uncommon among small businesses due to costs and complexities. They promise to pay employees a set level of benefits during retirement, based on a formula typically expressed as a percentage of income. DB plans generally require an actuary’s expertise.
Total contributions to profit-sharing and 401(k) plans cannot exceed $55,000 or 100% of compensation in 2018. With both profit-sharing and 401(k) plans (except safe-harbor 401(k) plans), you can impose a vesting schedule that permits your employees to become entitled to employer contributions over a period of time.
Unlike qualified plans that must comply with specific regulations, SEP-IRAs and SIMPLE IRAs are less complicated and typically less costly.
- SEP-IRA: A SEP allows you to set up an IRA for yourself and each of your eligible employees. Although you contribute the same percentage of pay for every employee, you’re not required to make contributions every year. Therefore, you can time your contributions according to what makes sense for the business. For 2018, total contributions (both employer and employee) are limited to 25% of pay up to a maximum of $55,000 for each employee (including yourself).
- SIMPLE IRA: The SIMPLE IRA allows employees to contribute up to $12,500 in 2018 on a pre-tax basis. Employees age 50 and older may contribute an additional $3,000. As the employer, you must either match your employees’ contributions dollar for dollar up to 3% of compensation, or make a fixed contribution of 2% of compensation for every eligible employee. (The 3% contribution can be reduced to 1% in any two of five years.)
For the self-employed
In addition to the options noted above, sole entrepreneurs may consider an individual or “solo” 401(k) plan. This type of plan is very similar to a standard 401(k) plan, but because it applies only to the business owner and his or her spouse, the regulatory requirements are not as stringent. It can also have a profit-sharing feature, which could help you maximize your tax-advantaged savings potential.
Are my student loans eligible for public service loan forgiveness?
If you are employed by a government or not-for-profit organization, you may be able to receive loan forgiveness under the Public Service Loan Forgiveness (PSLF) Program. The PSLF, which began in 2007, forgives the remaining balance on federal Direct Loans after you have made 120 monthly payments under a qualifying repayment plan while working full-time for a qualifying employer.
Qualifying employers for PSLF include: government organizations (e.g., federal, state, local), not-for-profit organizations that are tax-exempt under Section 501C(3) of the Internal Revenue Code, and other types of not-for-profit organizations that are not tax-exempt if their primary purpose is to provide certain types of qualifying public services.
If you plan on applying for PSLF in the future, you should complete and submit an Employment Certification form annually or when you change employers. The U.S. Department of Education will use the information on the form to let you know if you are making qualifying PSLF payments.
You can apply for PSLF once you have made 120 qualifying monthly payments towards your loan (e.g., 10 years). Keep in mind that you must be working for a qualifying employer both at the time you submit the application and at the time the remaining balance on your loan is forgiven.
Recently, PSLF made headlines due to the fact that many borrowers who thought they were working toward loan forgiveness under the program found out they were ineligible because they were in the wrong type of repayment plan. Many borrowers claimed they were told by their loan servicer that they qualified for PSLF, when in fact they did not. In 2018, Congress set aside $350 million to help fix this problem. The Consolidated Appropriations Act provides limited, additional conditions under which borrowers may become eligible for loan forgiveness if some or all of the payments they made on their federal Direct Loans were under a nonqualifying repayment plan for the PSLF Program. For more information on PSLF, visit studentaid.ed.gov.
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IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matter addressed herein.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018