What Happens to Your 401(k) and Your Partner’s Debt in a Divorce?
A divorce can be messy.
It can be especially messy if one spouse has a hefty 401(k) or other retirement account, and the other has racked up a lot of debt.
But what are the odds of getting divorced? After all, your marriage is great and you’re in love. Or so you think.
While divorce rates have been trending downward especially among younger couples since 2008, according to a study by the American Sociological Association, first marriages don’t always end so well overall.
A marital and family studies expert told ABC News that a rough estimate of the overall divorce rate of first marriages is 40-42%. That may be all you need to know to get you at least thinking about how your retirement fund and other assets would be divided in a divorce, and how your partner’s debt might be resolved.
Your retirement account
Remember your wedding vows? There was likely something in there about “for richer, for poorer” and “till death do us part.”
A divorce gets you out of staying together until you die, but a judge will decide how the richer and poorer part will be divided.
Very generally, what you brought into a marriage will remain yours upon divorce. Unless you have a prenuptial agreement that says your retirement account is all yours, your spouse will likely have some claim on it.
Laws differ by state, so these are general guidelines on how marital property works.
If you opened a retirement account after getting married, it’s marital property. If the account was opened before you got married, but you contributed money to it during the marriage, then some of the assets are marital property.
A judge will decide how to divide the account based on how much of the retirement fund was paid into during the marriage. Only the marital portion of the account will be divided. What you contributed and the earnings of the account before you got married should remain yours.
If you live in a community property state, then the spouse is entitled to 50% of marital assets. In common-law states the split doesn’t have to be made down the middle, but it has to be fair.
New York is a common law property state, and it follows what it calls equitable distribution laws. The common law property system states that property that one person acquired belongs solely to that person unless the property is specifically put in the names of both spouses.
Assets are divided “fairly” by a judge who considers factors such as the duration of the marriage, career opportunities given up, and the ability of each person to support themselves.
Another large state, California, follows community property laws that divide the couple’s joint assets in half. Factors such as the length of marriage and number of children aren’t taken into account when dividing assets.
To avoid IRS penalties for early withdrawals from retirement accounts, money can be rolled over from your account into your ex-spouse’s. Writing a check is considered a regular withdrawal and could be taxed.
A qualified domestic relations order
Retirement savings can be the largest and most valuable asset in a marriage. A Qualified Domestic Relations Order, or QDRO, can help distribute the funds equally and without penalty in a divorce.
A QDRO is a court order that can instruct your spouse’s pension or retirement plan on how to pay your share of plan benefits. It applies to defined contribution plan assets such as 401(k)s, but isn’t needed to divide IRA or SEP assets.
It is separate from a marital settlement agreement. A QDRO allows retirement plan funds to be separated and withdrawn without penalty and then deposited into the non-employee spouse’s retirement account. The order must be approved by the retirement plan’s administrator and the court.
The IRS allows cashing out a retirement fund under a QDRO, and it won’t be subjected to a 10% penalty for early withdrawal before age 59.5. The money taken out now will be taxed as regular income, however.
What about debts?
Another potential downside to a divorce is if you’re a saver and your spouse is a spender, what do you do about their debts?
The same caveats that applied to assets apply to debts. Laws vary by state, with some states accounting for the assets and debts each person brought into a marriage.
In community property states, everything is owned equally. It doesn’t matter who created the debts. A prenuptial agreement could deal with debts, putting them solely on whoever caused them.
Debts include much more than just credit card balances that have piled up. They can be any bill that arrives at your house, and don’t have to be long-term debts. If you’re living at your house but your spouse isn’t after a divorce, the garbage, electricity, water and other bills still have to be paid.
Who pays credit card debts?
Let’s assume you’re paying those bills. What about debts such as unpaid credit cards that a collection agency or creditor is after?
If the credit card was in both of your names, then you should have the payments listed in the divorce agreement. Once the balance is paid, you may want to cancel the card or take one person’s name off it.
If the divorce agreement isn’t followed and a spouse doesn’t make the payment, you can ask the court to enforce it and require your spouse to appear in court to explain why it isn’t being followed.
If a credit card is in one person’s name, then they should be responsible for paying the bill. However, a judge may decide that if you made charges to the card when you were married, then you’re responsible for at least half of the charges.
Also, credit card companies may seek payment from you even though your name wasn’t on the card. As a former spouse, they may consider you liable for payments.
You should expect to be held liable for debt that’s in your name. In general, you’ll be jointly liable for credit card debt taken out in both names.
Even if you aren’t contractually liable for your former spouse’s credit card debt, a judge may order you to pay part of it. Anything you bought with a credit card to run a household, for instance, could be a debt for both spouses.
A divorce decree isn't enough
A divorce decree ordering your spouse to pay your debt doesn’t cancel your contract with the credit card issuer. Showing your divorce decree to a creditor won’t erase your liability for the debt.
If the credit card is in your name and your ex doesn’t pay the debt as ordered by a judge, your best recourse may be to pursue them in court.
Another solution is to remove your name from those credit accounts. If you owe money, a creditor is unlikely to remove your name, even if someone else is legally ordered to pay the debt.
One option is for the spouse responsible for the payment to transfer the balance to a card in their name only with a balance transfer.
A little good news
There is one small bit of good news in all of this. Your credit history and credit score won’t change because of a divorce.
They are only yours, and will always be yours alone. They didn’t change when you got married and they don’t change when you get divorced.
Late payments on an account that you’re an authorized user on can affect your credit score if your ex-spouse isn’t paying the credit card bill. To avoid that, remove yourself as an authorized user or close joint credit card accounts.
The debts you create after a divorce are now solely yours. Having your former spouse’s name on an account could only add to your problems.