Older adults often need more money to plan for retirement and healthcare costs. Standards of living also continue to soar, which makes financial planning vital in “gray” divorces. A 2014 U.S. Government Accountability Office (GAO) report states that a single person age 65 or older needs 79 percent of the income of a two-person household. Financial needs among older people also vary between genders. National Center for Family & Marriage research shows that on average, women who divorce after age 50 experience a 45 percent drop in their standard of living compared to 21 percent for men.
As divorcing couples consider their futures, retirement pensions become a major part of asset division. That’s another reason why financial literacy is no longer optional for divorce attorneys. In this next chapter in our financial literacy series, we look at dividing retirement packages and Social Security in a “gray” divorce.
Retirement Pensions: the Golden Goodbye
Without a prenuptial agreement, a divorce is subject to the rules of the state where the couple lives, whether the laws involve equitable distribution or community property.
To avoid open-ended awards of spousal maintenance, one option is an unequal division of marital assets to pay the receiving spouse in lieu of support via splitting retirement assets.
Generally speaking, retirement savings accrued during a marriage are often considered marital. If a spouse added them before marriage, you should determine which part is marital through a statement that shows the account before the marriage. The latest statement and the plan rules and regulations can be helpful in determining how to divide the assets. Retirement packages are sometimes split equally (50/50), however, courts may divide them in different ratios.
Retirement accounts are usually either defined benefit or defined contribution plans. A defined benefit plan or pension identifies the benefit payable to the retiree and is usually based on a formula that factors the number of years a participant has worked for an employer and their salary. A defined contribution plan, such as a 401(k), places an employee’s contributions from their earnings and usually a matching contribution from the employer into a tax-free account to grow until retirement. The value of a defined contribution plan is the total account balance maintained for an individual under the plan as of any given date. In the process of division and determining the value, it’s important to be aware of such issues as market gains or losses, any existing loans against the benefits, and provisions for surviving spouses.
Taxes and penalties can also become an issue in retirement pension plans. Some have been funded with pre-tax dollars that may become taxable upon distribution. If the couple plans to split the retirement account, if it’s a 401(k), 403(b), or other company retirement plan, you can use a Qualified Domestic Relations Order (QDRO) to prevent early withdrawal fees and taxes. A QDRO outlines the rights a spouse has to part of an ex-spouse’s retirement benefits. QDROs might not be necessary for rollover Individual Retirement Accounts (IRAs). Government pension plans have their own rules for division.
Social Security Benefits and Limitations
If a marriage lasted ten years or more, some unmarried ex-spouses age 62 or older may be entitled to receive Social Security benefits through a former spouse. They must meet the following criteria:
- qualify for Social Security or disability benefits
- have been divorced for at least two years before they apply, whether or not the former spouse has retired
- the ex-spouse’s benefit must be larger than the benefit the spouse would receive from their own pension
The applying spouse will receive the greater of his or her own benefit (if they’re eligible) or the spousal benefit on the ex-spouse’s work record at full retirement age (currently age 66). If a spouse waits until full retirement age to apply as a divorced spouse, their benefits will be equal to half of their ex-spouse’s full retirement or disability benefit amount.
If the spouse qualifies for retirement benefits on their own record and former spouse’s benefits, Social Security will pay the retirement benefit first. If the benefit on the ex-spouse’s record is higher, the spouse will get an extra amount on their ex-spouse’s record so that the combination of benefits equals that higher amount.
Social Security reduces spousal payments if the retiring ex collected benefits before the full retirement age. The longer one waits to apply for Social Security benefits beyond the full retirement age, the higher the payout. To maximize their Social Security benefits, a divorced spouse can choose to collect on an ex’s record at age 66 and then receive their own benefits at age 70.
The amount of benefits the applicant gets doesn’t affect the ex-spouse’s benefits or those of their current spouse. If a divorced spouse continues to work while they receive benefits, the retirement benefit earnings limit still applies. If the spouse also gets a pension based on work Social Security doesn’t cover, such as government employment, it may affect their benefit on their ex-spouse’s record.
The spouse’s remarriage ends their access to the former spouse’s benefits, but if the marriage ends by death, divorce, or annulment, they become eligible again. Widows and widowers aren’t eligible for an ex-spouse’s benefits if they remarry before age 60. If a widow or widower receives benefits at age 60, they can remarry without losing their benefits.
Planning for the retirement of divorcing spouses helps everyone see their long-term financial outlook, and it can go a long way to increase the odds of happy golden years.
Our CFL course tackles these and other “gray” divorce financial topics. Learn how more knowledge of retirement pensions and other assets can help you advise your clients better in our free information packet today.
And don’t miss our free webinar:
Property Division Strategy That You Haven’t Heard Of Yet: For Clients With Real Estate
Thursday, April 7th at 4:00 pm EST.
In this special presentation for divorce practitioners, we will outline an effective strategy to limit settlement exposure, create liquidity, and eliminate tax liability. We will offer cutting edge techniques for divorce planning that involve clients who own commercial real estate.