It takes years of planning to ensure financial stability during retirement. Most professionals save for decades to enjoy their lives after leaving full-time employment. They set money aside in special accounts and may invest their resources to increase their value over time.
Unfortunately, retirement savings may be at risk during divorce proceedings. Couples often leave a marriage with less than they might hope to have to support themselves during their golden years. There are several ways in which divorce can diminish the value of retirement savings, including the three below.
1. The need to divide the accounts
Typically, spouses have to report the value of their retirement savings or pensions. They then have to factor in the value of that property when they divide their other assets and their marital debts.
In many cases, even accounts that only one spouse contributed to are vulnerable to division during a divorce. Unless one spouse prioritizes retaining retirement savings, they may have to spend years rebuilding their account after making distributions to a spouse.
2. Tax consequences and penalties
Dividing certain types of accounts can create secondary financial consequences. Several of the most popular retirement savings accounts provide tax deferral for income. For example, people make contributions to a 401(k) from their pre-tax income. They avoid paying taxes on what they contribute to their retirement savings account when they earn the money.
They then pay taxes on those savings as they withdraw them during retirement. Making a large withdrawal without the right documentation during a divorce can lead to tax consequences. The party that holds the account may also have to cover a 10% penalty for early withdrawals that can decrease the amount they have to rely on during retirement.
3. Withdrawals to cover divorce costs
Retirement savings are often among the only financial resources available to cover divorce expenses. Spouses often feel as though their best option is to withdraw money from retirement savings accounts to cover their divorce expenses.
While doing so can be a relatively expedient solution, it is not necessarily the best option available. The more intense and contentious the divorce becomes, the greater the overall cost of the divorce process. Spouses may find themselves withdrawing tens of thousands of dollars to cover their expenses.
For many people, ensuring their financial stability during retirement is a key goal during divorce proceedings. To achieve that goal, people have to manage their expectations and behaviors throughout the divorce process.
Understanding what typically happens to retirement savings during property division can help people prepare themselves for their own divorce process. Those with realistic divorce goals and a focus on long-term recovery can potentially preserve more of their retirement savings than those who succumb to their emotions and fail to strategize before the divorce process begins.
