Tuesday, February 24, 2009

Timely Actions are Important in a Divorce

An interesting tidbit came across my desk yesterday and it highlights a very important fact and one that is often overlooked. When you get divorced and have to separate assets you should do it in a timely manner. Don’t treat things in a cavalier fashion and don’t let your attorney do it either.

Of course I am not using real names here except when I mention Attorney Dratch.

John and Mary got divorced and in the settlement Mary was awarded 50% of John’s 401(k). A 401(k) plan is covered under ERISA and as a result it is necessary to have a Qualified Domestic Relations Order (QDRO) drafted, signed by the Judge and then honored by the Administrators of the 401(k) plan. The QDRO cannot be signed nor presented prior to the divorce but it certainly could be prepared and ready to be presented to the Judge when the divorce is being granted.

Subsequent to the divorce John lost his job and rolled his 401(k) into an IRA. He must have told his employer that he was not married because when you are married a 401(k) distribution requires the approval of your spouse.

There is no longer a 401(k) to split and the protections afforded an IRA are less than that afforded an ERISA plan. However John does want to comply with the Court Order and transfer half of his IRA to his ex spouse. Why is it difficult? The Separation Agreement makes no mention of an IRA. An IRA can be transferred to an ex-spouse with no tax consequences provided it is part of a divorce settlement. There are no papers that indicate that John is supposed to transfer the IRA and the custodian cannot just take his word.

As a result of the QDRO not being prepared in a timely manner Mary has not gotten access to her funds. In addition the availability of the funds is more advantageous when they are coming from an ERISA plan than when they are coming from an IRA.

What can be done?

If 60 days have not elapsed since John transferred the money from the 401(k) to the IRA he may be in a situation to transfer some of it back. If he is allowed to then the QDRO can be prepared and executed and Mary can access the funds.

They can go back to Court and have the settlement modified to reflect the division of the IRA instead of the 401(k).

If Mary wants the cash then John can cash it out and give Mary the money. However this will be a taxable event and be subject to a 10% early withdrawal penalty. Depending on the incomes this could be a 49% hit, including State tax.

All of this could have been avoided had the QDRO been ready at the time of divorce or shortly thereafter. In addition Mary’s Attorney could have written a letter to the Administrator of the 401(k) plan advising them of the divorce and that a QDRO is being prepared. With that letter on file it is more likely that John would not have been able to move the money to an IRA.

After my own divorce there were a number of post divorce issues that needed to be taken care of. We needed a QDRO to move some of my 401(k) to my ex and a QDRO to move money from hers to me.

I recall telling her lawyer, Barbara Dratch that I would take care of it. Curtly she said no that she would and I asked why. “Because it is my job to protect the interests of my client” was her response.

A light went off in my head and those words are so true. In a divorce it is your attorney’s responsibility to protect you and that includes timely preparation of all paperwork. Attorney Dratch also sent a letter to the administrator. While I wasn’t thrilled at the time I now appreciate how important those actions were.

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