How to Protect Your High Net Worth Retirement Accounts During Divorce
7 Smart Tips to Ensure Your Divorce Doesn’t Derail Your Long Term Financial Prosperity
Divorce is messy. For high and ultra high net worth households and their retirement accounts, divorce is really messy.
Depending on how contentious your potential divorce is shaping up to be, you might think your primary goal is to protect your retirement accounts from your spouse. But in reality, there are at least three parties involved: You, your spouse, and the government. If you own a business, there’s a fourth party.
The tax consequences of divorce can very quickly spiral far beyond what you thought you’d have to pay to your spouse as part of a settlement. When you also toss in the legal fees and your possible counseling and therapy mental health bills, you’re looking at losing a lot of money before this process is over.
For affluent business owners, the costs just keep piling on like a rugby ruck. Look at Amazon founder Jeff Bezos, who just lost $35 billion, in an instant, when he divorced his wife MacKenzie. The amazing thing about Bezos’ story though, is that it could have been much, much worse.
Had MacKenzie wanted to, she could have caused great disruption in his life and tried to extract far more than that, as well as complicate his many business ventures. Fortunately for him, she just took her $35 billion and ran, letting him keep the Washington Post, Blue Origins, and all his Amazon voting shares, in addition to 75% of his wealth.
What about you? Would your spouse be as gracious?
If you own a business, your spouse owns a share of it too, unless you’ve specifically spelled out in a prenuptial agreement that he or she doesn’t. For high net worth couples, Pillar recommends you get a prenuptial agreement. The potential costs of neglecting this protective step are simply too high.
And what about your retirement accounts? Your spouse owns a share of those too. Divorce and its effects on retirement accounts gets so murky that whole IRS tax publications have been written just for this one aspect of the separation.
If you’re a high net worth household facing a potential divorce and you want to protect your retirement accounts, start working through the following task list. It might save you millions.
Protecting Your Retirement Accounts During and After Divorce
The primary thing you must remember is that retirement accounts are not fixed entities. They keep growing even after you get divorced. If you get divorced, you will most likely have to pay your spouse a portion of your retirement accounts and pensions.
So the goal of this article isn’t to help you figure out how to avoid paying anything. That’s possible, but probably not realistic in most cases. The goal is to minimize the effect of your divorce on what remains of your retirement accounts afterward, and keep it secure as you move forward.
Here are 7 things high net worth individuals can do to protect their retirement accounts during a divorce.
1. Get a QDRO – Qualified Domestic Relations Order
A QDRO is, according to the IRS, “a judgment, decree, or order that a retirement plan must pay child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent.”
The QDRO spells out who will be paid from each retirement account, how much, and how many payments are required.
You need a tax lawyer and a financial advisor to help you work through your divorce, and this is one reason why. Your divorce lawyer doesn’t have the expertise for this sort of thing, and isn’t required by law to mention it.
Some couples have gotten divorced without even knowing or thinking about this, because they might only be in their 30s and retirement wasn’t on their minds. It’s extremely complicated and frustrating to go back ten, twenty years later and re-open a divorce so you can create and enforce a QDRO.
Don’t go there.
One money-saving reason to get a QDRO is because it exempts you from paying the 10% early withdrawal penalty on your retirement accounts. Whichever spouse receives the payment can take it in full, even if they’re not yet at the minimum age for withdrawals. To be clear – they’ll still have to pay taxes on it, which is one reason to consider a rollover.
But this is where it all gets very complicated, and only a financial advisor with extensive experience working through these details – specifically for high net worth couples – will be able to help you navigate it all so both of you get the best possible deal and don’t lose money to taxes and fees.
Find a high net worth financial advisory specialist (such as Pillar), and ask them to help you create a QDRO.
2. Know the Rules of Your Retirement Accounts
The great challenge with QDROs is that every retirement account has different rules.
For example, one government retirement plan requires the use of a specific term (TSP balance) in the QDRO where it describes how the money in the account will be distributed. Leave out that term, and you risk nullifying the order.
But that’s only for that one government retirement plan, which you probably don’t use.
There are thousands of retirement plans. Each IRA, 401(k), Roth, 403(b), and the companies managing these and other types of accounts have their own sets of rules.
In order to create an enforceable QDRO, you’ll first need to find out the rules that your retirement accounts require you to follow.
3. Take an Inventory of Your Assets
Hiding assets from your spouse doesn’t work. Plus, it’s illegal. You need to know every asset you own – not just money and retirement accounts.
Let’s say you own two homes, but you also own an apartment complex halfway across the country that generates some nice passive income. That’s a marital asset. When you’re negotiating the terms of the divorce settlement, you’ll need to decide how to split up this asset too.
How does that affect your retirement accounts?
Because the idea of just ‘splitting everything 50/50’ oversimplifies the reality of situations like this. What’s more likely is that one spouse will retain control of the apartment, and the other will get something else. Much like the Bezoses did. MacKenzie let Jeff have the Washington Post. Why? She likely just didn’t want to be involved with it. So he got that asset in full. But, that also gave her more leverage to get other things she wanted.
In other words, you don’t have to split your retirement accounts 50/50. You can negotiate this. Having a clear and complete picture of all your assets makes it easier to decide who gets what, and it broadens the picture beyond just the cash.
You have houses, cars, perhaps businesses, artwork, and income coming in from a variety of sources, as well as many other types of assets.
All of it is in play.
If you want to protect your retirement accounts and perhaps keep more than half of them (or even all of them) for yourself, consider giving some of these other assets to your spouse in exchange. That’s just one idea of course, and in no way does this article represent any form of legal advice.
4. Take an Inventory of Your Debts
What you’ve earned, your spouse owns too. What you owe, they also owe. You share your debts as well as your assets.
Do you know everything you and your spouse owe to debtors? Anything hidden? Nothing takes a bite out of your retirement goals more than a huge debt you forgot about (or weren’t ever told about – financial disputes are one of the leading causes of divorce).
These too can be negotiated in your settlement, just like your assets. So get them on the table.
5. Make Spending Adjustments NOW
You’re going to lose something. That’s why divorces are painful, and a thing to be avoided whenever possible.
But if you’re spending $250,000 per month in your current lifestyle, you can protect your retirement account by scaling back a bit. Reduce your spending to $150,000, or even lower, and you will extend the life of your retirement accounts.
It’s a drastic measure to adjust a lifestyle you’ve become accustomed to, for sure. But this all comes down to what’s most important to you.
6. Have a Timeline and Don’t Get Sidetracked by Nitpicking
What does this have to do with your retirement account? Think of it this way:
Every dollar you spend during your divorce is one less dollar that goes toward what remains of your retirement accounts. Where does your money go during a divorce?
To your lawyer. (Who else?)
If you let your lawyer have free reign of this process, and tell him things like “get everything you possibly can for me,” he may take that as a license to parse the wording and punctuation of every sentence in your settlement agreement. Be careful about that. Is the money you’ll be paying your lawyer worth whatever he or she gets for you?
The faster you can push this process along, the less it will cost you. So do your best to create a timeline and stick to it. And the more you and your spouse can agree upon in advance, the less your divorce will cost you in the long run, and the more you’ll get to keep in your retirement accounts.
7. Beware the Tax Man – Get an Advisor in Your Corner
Alimony counts as income in most cases, but child support doesn’t. Retirement account distributions to an ex-spouse count as income. And what about your pension? If one of you remarries after the divorce, this affects your survivor benefits.
All of this and so much more affects your taxes. The tax bite during a divorce isn’t like a snakebite. The snake just bites once and waits for you to die. During a divorce, it’s more like a piranha. A nonstop feeding frenzy.
Your financial advisor should know how to help you minimize taxes – for you and your spouse – that result from your final settlement agreement.
Therefore, to minimize taxes, your very best move is to go find a financial advisor who not only works exclusively with high and ultra high net worth clients, but who has extensive experience helping them navigate the financial fallout from a divorce.
A fiduciary financial advisor operates out of your best interests. Even during a divorce, that’s still their primary function. If it’s in your interests to protect your retirement accounts by minimizing your taxes, that’s what your advisor will prioritize throughout this painful process.
You want someone in your corner who’s obsessively paying attention to those details, because you won’t have the bandwidth for it.
Getting Divorced? Get Expert High Net Worth Financial Advice
Pillar’s wealth managers have over 60 years of combined experience working exclusively with high and ultra high net worth investors in Silicon Valley and the San Francisco Bay Area. And we have been there for many clients as they’ve gone through messy divorces they didn’t anticipate happening.
With us by your side, we will protect your retirement accounts and make sure that regardless of what happens in your divorce, your long term financial security is strong and stable.
If you’re in the early stages of a divorce, or suspect you may be soon, now is the time to secure the expert help you’ll need on your team to get the best possible outcome.