By John K. Grubb, Attorney
5005 Riverway
Suite 450
Houston, Texas 77056
713-877-8800

The Texas Family Code provides that, in a divorce proceeding, retirement and employee benefits must be disposed of.  One of the most common types of employee benefit or retirement benefit is a 401k plan.  The term “401k” stands for the section of the Internal Revenue Code which establishes a type of defined contribution plan referred to as a qualified cash, or deferred arrangement whereby employees can contribute an amount of money each year to a retirement plan and the employer may make certain “matching” contributions.  The advantage of 401k plans to the employee is that their own contributions, the employer’s contribution, and any plan earnings are not taxed until the employee withdraws the money.

In Texas, 401k plans can be separate property (acquired before marriage), community property, or a combination of both separate and community property.  Frequently, it is necessary to trace the assets in a 401k plan to determine if the assets are separate property, community property, or a combination of both.

Since contributions to 401k plans are automatically withdrawn from an employee’s earnings, offer matching employer contributions, and significant tax advantages, in many cases they are the largest, or one of the largest, assets in a Texas divorce.  And it does not matter whose name the 401k is in – in Texas, the community portion must be addressed in a divorce settlement or divided by the Court if the parties cannot settle the division.

In Texas, 401k plans add to the complexity of property division in a divorce.  Each plan is different.   An experienced Houston divorce attorney can untangle the intricacies of 401k plans and help you receive a fair divorce settlement or division by the Court if a settlement cannot be reached.

Legal Requirements for 401k Divorce Division

Texas community property includes tangible and intangible possessions acquired during a marriage. 401ks and other retirement plans may be considered community property in divorce.

Splitting 401k property is complex, and must satisfy specific legal requirements. There are various explicit constraints to be met on both federal and state levels, such as:

• Federal Employees Retirement Incomes Security Act (ERISA); and
• Qualified domestic relationship order (QDRO) signed by the Judge.

A QDRO is a domestic relations order which creates, or recognizes, the existence of an alternate payee’s right to, or assign to an alternate payee the right to, receive all or a portion of the benefits payable with respect to a participant under a plan. In short, it perfects and divides an alternate payee’s award from a participant’s plan. The QDRO explicitly describes the what, when, and how details of the 401k property division. The legal requirements must be meticulously prepared and verified. If the QDRO is not properly executed and followed, you will experience delays in the settlement and/or a hefty tax liability, if you’re lucky. Alternatively, an ill-prepared QDRO may result in one party receiving more or less than what he or she was awarded in the Divorce Decree. The process is not as simple as filling out and filing a form.

Divorce 401k Property Division

Texas courts are obligated to ensure divorce community property is divided in a “just and right” manner. I need precise information about the 401k plan –typically a year-end statement – in order to have all of the necessary information to prepare a QDRO or have it prepared.  If you can’t get the information from the plan administrator, John K. Grubb & Associates can either subpoena the records or request them through the formal disclosure process.

Of course, if all of the contributions made to the plan were made while married, then the entire current balance of the plan is community property.

What happens if part of the contributions were made to the plan before marriage and part were made while married?  It is then necessary to determine what portion of the plan is separate property and what portion is community property.  There are several methods used to value the 401k community property portion. Some common approaches are:

1. Dividing the total value of the 401k by the total number of months paid into the plan and then multiplying the result by the number of months of the marriage;
2. Using as the numerator the number of months married while contributing to the plan, using as the denominator the total number of months the employee has contributed to the plan and multiplying the resulting percentage by the current total value of the plan;
3. Subtracting the value of the 401k on the day of the marriage from the value of the plan on the day of the divorce; and
4. Tracing the individual plan contributions each year to specific assets within the plan and then determining the current value for each specific asset currently in the plan.

Divorce 401k Property Division Settlement

When a 401k is divided in a divorce, the employee spouse becomes what is known as the “participant” and the non-employee spouse becomes what is known as the “alternate payee”. According to the Internal Revenue Code, any distribution to an alternate payee pursuant to a QDRO is not subject to the 10-percent additional tax (aka, the penalty tax); however, if the alternate payee elects to withdraw the funds, the alternate payee will have to pay federal income taxes on the withdrawals.

Some people do not want to divide their 401k in a divorce settlement – they want to keep the entire 401k for themselves. All options should be carefully considered in light of your financial goals. The two most common preferences are:

1. Taking the present value of the community portion of the 401k plan, subtracting estimated taxes, and offering to pay your spouse an amount close or equal to 50% of the after-tax value; and
2. Offering you spouse other assets in lieu of a portion of your 401k – say they keep all of the equity in the house or they get a much larger portion of the stock portfolio or some other community asset.

The QDRO

The QDRO should be signed at the time the Final Decree of Divorce is signed.  After the QDRO is signed, a certified copy of the QDRO and the Final Decree of Divorce has to be served on the 401k’s plan administrator.  The plan administrator then has to review the QDRO to make certain that it does not require the plan administrator to do anything that violates the terms of the 401k plan (remember each plan is different).  The plan administrator has 60 days to accept or reject the QDRO.  If the plan administrator accepts the QDRO, then the plan administrator divides the 401k account into two separate accounts – one account for “the participant” and another account for “the alternate payee”.  Once the alternate payee’s 401k account is set up, they are free to leave assets in their own 401k account with the plan administrator, withdraw the funds and pay taxes on the funds, or roll the funds over to an IRA rollover and pay no taxes on the rollover.

When dealing with the added complexity of a 401k during a property division in a divorce, it is imperative that you consult with a knowledgeable attorney. Contact Houston attorney John K. Grubb & Associates, PC, to learn about how a 401k will affect you in a Texas divorce.