You've spent most of your life planning and saving for retirement. Something you might not have planned for, though, is a divorce. Besides the emotional aspects of the dissolution of your marriage, divorce can have a large impact on your retirement savings.
How might a divorce affect my retirement?
A recent study found that, on average, divorced individuals have saved $11,000 less for retirement and are more likely to feel unprepared financially for retirement. Furthermore, divorce may reduce your income, requiring you to continue working for years after you'd hoped to retire or even forcing you to find a part-time job after you have retired.
Divorce mistakes that might have negative retirement consequences
Especially if you are over the age of 50 and suddenly find yourself in the midst of divorce proceedings, there are some careful decisions you may want to consider when it comes to issues of asset division and how these choices might adversely affect your retirement. Common missteps include:
- Keeping the house without considering other financial assets
- Not considering tax implications of retirement funds
- Immediately rolling over a spouse's retirement account into an IRA
- Withdrawing too much from retirement savings
Keeping the house without considering other financial assets
You may assume you are better off taking the house during asset division, but this is not necessarily the case. When compared to retirement savings, a house's future value is harder to estimate, and a home will likely have unforeseen expenses and need ongoing upkeep. It is also usually easier to use a 401(k) or an IRA to finance retirement than it is to use a house. A lawyer can offer insight into the potential appreciation and tax consequences for retirement funds versus the value of the house.
Not considering tax implications of retirement funds
Speaking of tax consequences, you will probably want to carefully consider the differences between pre- and post-tax accounts. With pre-tax accounts, like IRAs and 401(k)s, you will owe taxes when you withdraw the money in retirement. However, when you withdraw money from post-tax accounts, like Roth IRAs during retirement, those monies will not be taxed a second time. You will likely want to take this into account when deciding on asset division during divorce, as $500,000 in a pre-tax account is not the same as $500,000 after taxes.
Immediately rolling over a spouse's retirement account into an IRA
You are probably aware of the 10 percent tax penalty for early withdrawal from retirement accounts. What you might not know about is the one-time opportunity for a divorcing spouse under the age of 59 and a half to withdraw money from an ex-spouse's 401(k) or 403(b) without paying that penalty.
The only stipulation for doing so is that a Qualified Domestic Relations Order (QDRO) must allocate the assets. A QDRO is a court order that, among other things, details how your spouse's pension plan will pay your share of benefits. A lawyer can offer guidance, but you may want to consider making a withdrawal from the retirement account to help pay some of the unavoidable expenses of divorce, instead of immediately rolling over all funds.
Withdrawing too much from retirement savings
However, it is possible to go too far in the other direction and withdraw too much from the retirement savings. Yes, you'll be avoiding that 10 percent early withdrawal penalty, but remember that you will need these savings to live on for decades during retirement.
How can I avoid these mistakes?
Divorce, especially a divorce later in life, can be a twofold blow. Not only might you be overcome with emotions during such a stressful event, but any seemingly small mistakes can end up having dire financial consequences in the future. A knowledgeable Alabama divorce attorney with experience in asset division will be able to offer sound legal advice and help guide you around potential missteps you might not even know to consider, helping you move past this bump in the road toward a brighter future retirement.