RETIREMENT & DEFERRED COMPENSATION

Retirement assets are frequently the second largest item in a marital estate and the one where the division mechanism most directly determines the tax result.

Two things are commonly misunderstood. A traditional retirement account is not worth its balance — every dollar is taxed as ordinary income on withdrawal. And the correct mechanism differs by plan type, with a mistake producing an immediate taxable distribution to the wrong spouse.

THE MECHANISM DEPENDS ON THE PLAN

• Qualified plans — 401(k), pension, 403(b). Divided by qualified domestic relations order. A QDRO must satisfy statutory requirements and be approved by the plan administrator. A division outside a QDRO is a distribution, taxed to the participant.
• IRAs. Not divided by QDRO. Transferred under a divorce instrument pursuant to section 408(d)(6). Using the wrong mechanism produces a taxable distribution.
• Non-qualified deferred compensation. Section 409A constrains timing and form of payment, and these plans frequently cannot be divided at all — requiring an offset elsewhere in the estate.
• Equity compensation. Options, restricted stock, and RSUs raise vesting, transferability, and character questions, and unvested awards raise the further question of what portion is marital.

THE VALUATION PROBLEM

A $1,000,000 traditional retirement account and $1,000,000 in a taxable brokerage account are not equivalent. The retirement account is taxed as ordinary income on withdrawal, at the recipient’s rate, whenever taken — with a penalty if taken early. Its after-tax value may be sixty to seventy percent of face.

A Roth account has the opposite profile. A pension not yet in pay status has to be valued actuarially. Treating any of these at face on the schedule mis-prices the settlement.

WHAT THE FIRM DOES

Values retirement and deferred compensation on an after-tax basis, identifies the correct division mechanism for each plan, reviews the QDRO or transfer language against the plan document before it is entered, and coordinates with the litigator so the order does what the agreement intends.

ELSEWHERE IN THIS SECTION

• Divorce Special Counsel — the overview, and how the engagement is scoped
• The Tax Gap in Divorce — Why the litigator and the forensic accountant both correctly decline the question, and what falls through between them.
• Testing Tax Claims Across the Table — An asserted tax consequence is a legal position, not a fact. It can be verified, and it is frequently wrong.
• After-Tax Value of Marital Assets — Basis, built-in gain, recapture and character — and why dividing the schedule down the middle is rarely an equal division.
• International Assets in a Marital Estate — Foreign trusts, PFICs, offshore holding companies and non-US pensions, where the penalty exposure can exceed the asset.