As a Divorce Financial Strategist™ I am frequently asked, "Can I take money out of my 401K before/during my divorce?"
Or sometimes it is asked like this, "Can my spouse take money out of his/her 401K before or during our divorce?"
The short answer is, "It depends."
Typically, the amount in a 401K plan that is accumulated during a marriage (and its appreciation, if any) is considered martial property. In Equitable Distribution states, this means that the amount in the account (along with all other assets and liabilities) should be divided according to what is "fair and equitable." In Community Property states, 401K funds accumulated during the marriage are divided in accordance with that state's laws (usually 50-50). For more information on Equitable Distribution and Community Property states, please see my previous HuffPost article.
However, a potential issue is that funds might be withdrawn by the account holder before or during the divorce (your spouse cannot take money out of your 401K and vice versa). If you are concerned that your spouse may try to take a loan or withdraw funds from his/her 401K, you can contact the plan's sponsor and see if they will flag the account to prevent any loans or withdrawals without first notifying you. They might be able to do so, if the plan allows it.
While some plan sponsors or employers do not require spousal consent for an employee to take a loan or make a withdrawal from his or her 401K, many do. Also, not every 401K plan sponsor allows loans or withdrawals and those that do may impose certain restrictions. In addition, there are numerous Federal restrictions. For example, you can only borrow up to 50% of your vested account balance up to a maximum of $50,000.
If your divorce settlement states that you will divide retirement funds, a court must order a qualified domestic relations order, commonly abbreviated as QDRO (pronounced as Quadro). A QDRO allows the funds in a retirement account (e.g. pension plans, 401Ks) to be separated and withdrawn without penalty and deposited into your respective retirement accounts or rolled-over into an IRA. A QDRO is not needed to divide an IRA.
Once the funds have been transferred using a QDRO, you own them and can start making additional contributions and invest the proceeds as you see fit. At this point, your ex-spouse has no control over how you handle the account.
But, do you really want to split the 401K?
No one asset, especially retirement accounts, should be looked at in isolation during your divorce settlement negotiations. You should be taking a holistic approach when dividing assets and liabilities during a divorce. Sometimes people suffering stress and anxiety during their divorce fail to look at the full scope of the situation and make decisions without doing the proper research and getting competent financial and legal advice. In the end, you may not want to divide retirement accounts if you and your soon-to-be ex, for example, decide that one of you gets the 401K and the other gets the house. Remember, if you do choose the house you will have numerous additional expenses to contend with, such as mortgage and tax payments, upkeep and repairs, etc. Nevertheless, it is absolutely critical that you carefully review all the short- and long-term financial and tax implications of your decisions. For instance, unless the 401K is a Roth 401K, the money in that account is pre-tax dollars (meaning, you haven't yet paid taxes on it). Therefore, the money in a 401K account does not have the same value as an identical amount of money in a bank account (most likely, you have already paid taxes on the money in your bank account).
Although there might be some legitimate reasons to borrow money from your 401K (like purchasing a home or paying medical bills), you should consult with your divorce financial analyst to see if it makes good financial sense to do so. Even though many are tempted to tap into this ready source of cash, it should probably be a last resort. Many 401K plans allow you to borrow against your plan balance, but you will lose the earning power of those funds and have to pay yourself back over a 5-year period with interest. Remember, if you borrow from your 401K and fail to pay it back, you will be deemed to have taken an early withdrawal on the money and will have to pay federal and state income taxes and a 10% penalty if you are under age 59 ½.
Since any funds, and any appreciation, accumulated in the 401K during the marriage is marital property, any funds taken out of a 401K prior to or during divorce by one spouse needs to be properly accounted for and the other spouse's share of those removed funds must somehow be added back into his/her "column" to even things up. However, if the funds were used for marital expenses or were otherwise used for the benefit of both spouses this would not be necessary.
There are many financial decisions to make during your divorce. They often require complex mathematical computations and a thorough knowledge of tax and financial rules. This is especially true when it comes to dividing retirement funds. Dividing retirement funds improperly can result in serious long-term consequences. Having a qualified divorce financial planner will not only keep you out of trouble, but also help secure your financial future.
Jeffrey A. Landers, CDFA™ is a Divorce Financial Strategist™ and the founder of Bedrock Divorce Advisors, LLC (http://www.BedrockDivorce.com), a divorce financial strategy firm that exclusively works with women, who are going through, or might be going through, a financially complicated divorce. He also advises women business owners on what steps they can take now to "divorce-proof" their business in the event of a future divorce. He can be reached at Landers@BedrockDivorce.com.
All articles/blog posts are for informational purposes only, and do not constitute legal advice. If you require legal advice, retain a lawyer licensed in your jurisdiction. The opinions expressed are solely those of the author, who is not an attorney.