By FPA member Barbara D. Heft, CFP®, CDFA™
Last Updated: June 6, 2011
When faced with divorce, there are issues relating to retirement that are easily overlooked, yet critical for the later years. Among the areas not to be disregarded are retirement and Social Security benefits, insurance needs and estate documents.
Prior to finalizing a divorce settlement, it is important to very carefully examine the valuation of retirement plans such as Individual Retirement Accounts (IRAs), pensions, 401(k)s, 403(b)s, thrift savings plan (TSP), profit sharing, money purchase, stock options, annuities, and deferred compensation plans. Other plan types include those provided by the Federal government, individual states, counties, municipalities and unions. Retirement benefits can be valued by several different methods, each of which may provide different results. One way is to calculate the total contributions made along with the accrued interest. Another method is to calculate the present value of future benefits expected to be received after retirement. Finally, a determination can be made of a percentage of the future benefits earned by the employed spouse to be allocated to the non-employed spouse. Deciding which method to use will be based on the circumstances of each individual situation. In order to transfer benefits within an employer-sponsored plan subject to the Employee Retirement Income Security Act (ERISA), a Qualified Domestic Relations Order (QDRO) must be approved by both the plan administrator and the court. Dividing an IRA is often simpler. A one-time distribution from an IRA may be rolled directly into a former spouse’s IRA without being subject to taxation or the 10 percent early withdrawal penalty if under age 59 ½.
Often a spouse with the lower income does not realize that there is the possibility of drawing Social Security benefits based on the former spouse’s retirement benefit. For this example, let’s assume that the wife is the lower wage earner. Based on current law, if the couple had been married for at least 10 years, the wife would be entitled to half of her ex-husband’s Social Security Retirement Benefits if:
- He is eligible for benefits.
- She is not married.
- She is at least 62 years old.
- Her own Social Security Retirement Benefits would be less than that of her ex-husband.
An ex-wife who is at least 62 years old and has been divorced for at least two years would be able to receive benefits based on the earnings of her ex-husband regardless of whether he has retired or applied for benefits. If her ex-husband dies, she may then be entitled to a widow’s benefit based on the following:
- Her ex-husband was entitled to Social Security benefits.
- They were married for at least 10 years before the divorce was final.
- She is at least 60 years old (or between ages 50 and 60 if disabled).
- She is not married.
- Her own benefits are not greater than what she would receive as a widow.
None of these situations would impact her ex-husband’s benefits or those of any other subsequent wives.
There are several situations in which life insurance may be beneficial to someone’s long-term financial planning. Suppose one spouse is eligible for a pension and the other will receive a lifetime benefit as part of the divorce settlement. Should the pensioned spouse die before retirement, the other spouse would lose the lifetime income. Purchasing term insurance to cover the pre-retirement period would ease this uncertainty. Similarly, purchasing life insurance on the spouse providing spousal maintenance and/or child support would go a long way to ensuring the continuity of this income stream should that individual die prematurely.
Finally, frequently there is a post-divorce impression that a will and other estate documents are no longer important. When a person dies intestate, or without a will, there is no testamentary evidence of that person’s wishes as to how the estate is to be divided. This requires probate court intervention; property is thus distributed based on state law. Even with a seemingly minimal estate, it is beneficial to create a will. Waiting until a divorce is final can be problematic should one pass away while separated. It is often recommended that interim estate documents be written soon after separation and then, if necessary, revised once the divorce is finalized. It is also important to revise the general durable power of attorney, health care power of attorney and advanced medical directive early in the separation process to ensure that the appropriate individual is named to act on one’s behalf.
The process of ending a marriage is often overwhelming. These are just a few of the issues that should not be overlooked. Availing oneself of appropriate resources and professionals may help provide guidance during such an emotional and challenging period.
FPA member Barbara D. Heft, CFP®, CDFA™, is employed at Law & Associates, Inc. in Glen Echo Md. just outside of Washington D.C.