King & Wood, P.A.

You Need a Buy-Sell Agreement for Your Business

“What happens at your company when a shareholder dies or becomes disabled, or wants to leave? These are just two of the potential scenarios that can be properly addressed with a buy-sell agreement.”

Every business should have a buy-sell agreement to protect the owners, their families, employees and the company. Without a buy-sell agreement or succession plan, any company is at risk, notes a recent article titled “Why does your business need a buy-sell agreement?” from the Philadelphia Business Journal.

Many business owners are reluctant to recognize the possibility of their becoming disabled or dying, so they put off creating a buy sell agreement. However, as we all know, unexpected events happen and it’s always better to be prepared.

A buy-sell agreement offers protection first by establishing what type of triggering events could happen and defining the terms and conditions for how shareholders will enter and exit their ownership of the business.

Companies often have a buy-sell agreement stuck in a file drawer from ten or twenty years ago. Chances are that big changes have taken place in the business and the old agreement is no longer relevant. The day-to-day operations of a business are pressing, and there’s never enough time to get around to it. However, when the unexpected occurs, shareholders are left to negotiate among themselves during the worst possible time.

A well-drafted buy-sell agreement should address the most common events: death, disability, divorce, personal bankruptcy, voluntary termination, retirement and involuntary separation. The agreement should clearly state the percentage and type of ownership, how shares are valued and how any insurance proceeds are to be handled. Without knowledge of the value and terms of payment, there’s no way to provide protection for a triggering event.

Once the value of the company and its shareholders is defined, it may become clear that a business needs to close a valuation gap.

The intentions for the future of the business can also be clarified through this process. Some provisions to consider are:

• How to notify other shareholders, in the event of a voluntary termination.
• Trailer provisions to protect exiting shareholders, in the event of a subsequent liquidity event.
• Discounts on value or extended payment terms for non-compliance of notification provisions.
• Insurance portability provisions to allow existing shareholders to reassign beneficiary designations (once payments owed to the exiting shareholder have been made).

Businesses are dynamic entities with frequent changes, so buy-sell agreements should be reviewed and updated in the same way that an estate plan needs to be updated—every three or four years.

Reference: Philadelphia Business Journal (Sep. 1, 2021) “Why does your business need a buy-sell agreement?”

How to Protect an Estate from a Rotten Son-in-Law

“Whatever the reason, whether your life is a bed of roses or a getting-worse-nightmare, there are things you can do now to insure what you leave will go to who you want. And when. And in what portion or portions.”

If you’ve been working for a while, you have an estate. If you’ve been working for a long time, you may even have a sizable estate, and between your home, insurance and growing retirement funds, your estate may reach the million dollar mark. That’s the good news. But the bad news might be an adult child with a drug or drinking problem, or a child who married a person who doesn’t deserve to inherit any part of your estate. Not to mention an ex-spouse or two. What will happen when you aren’t there to protect your estate?

There are steps to protect your estate and your family members, as described in the recent article “Is your son-in-law a jerk? Armor plate your estate” from Federal News Network.

Don’t overlook beneficiary designations. Most employer-sponsored retirement and savings accounts have beneficiary designations to identify the people you wish to receive these assets when you die. Here’s an important fact to know: the beneficiary designation overrides any language in your last will and testament. If your beneficiary designation on an account names a child but your will gives your estate to your spouse, your child will receive assets in the account, and your spouse will not receive any proceeds from the account.

Don’t try to sell a property for below-market value. The same goes for trying to remove assets from your ownership to qualify for Medicaid to cover long-term care costs. Selling your home to an adult child for $1 will not pass unnoticed. Estate taxes, gift taxes, income taxes and eligibility for government benefits can’t be avoided by this tactic.

A common estate planning mistake is to name specific investments in a will. A will becomes part of the public record when it is probated. Providing details in a will is asking for trouble, especially if a nefarious family member is looking for assets. And if the sale or other disposition of the named asset before your death impacts bequests, your estate may be vulnerable to litigation.

How will you leave real estate assets to heirs? Real estate assets can be problematic and need special consideration. Are you leaving shares to a vacation home or the family home? If kids or their spouses don’t get along, or one person wants to live in the home while others want to sell it, this could cause years of family fights.

Making a bequest to a grandchild instead of to a troubled adult child. Minor children may not legally inherit property, so leaving assets to a grandchild does not avoid giving assets to an adult child. The most likely guardian will be their parent, undoing the attempt to keep assets out of the parent’s control.

Include a residuary clause in a will or trust. Residuary clauses are used to dispose of assets not specifically mentioned in a will or trust. Your estate planning attorney will create the residuary clauses most appropriate for your unique situations.

Prepare for the unexpected. Your estate plan can be designed to address the unexpected. If a primary beneficiary like a daughter or son divorces their spouse, a trust could prevent the ex from gaining access to your assets.

An effective estate plan, prepared with an experienced estate planning attorney, can plan for all of the “what ifs” to protect loved ones after you have passed.

Reference: Federal News Network (Sep. 1, 2021) “Is your son-in-law a jerk? Armor plate your estate”

Common Estate Planning Mistakes and How to Avoid Them

“Even those with the best of intentions can fall into the trap of estate planning misinformation. Estate planning attorneys frequently hear rumors and ill advice disguised as facts.”

Every family has one: the brother-in-law or aunt who knows everything about, well, everything. When the information is wrong, expensive problems are created, especially when it comes to estate planning. Estate planning attorneys devote a good deal of time to education to help prevent unnecessary and costly mistakes, as described in the article “Misinformation, poor assumptions result in major planning mistakes” from The News-Enterprise.

The most common is the idea of a “simple” estate plan. What does “simple” mean? For most people, the idea of “simple” is appealing—they don’t want to deal with long and complicated documents with legal phrases they don’t understand. However, those complex phrases are necessary, if the estate plan is to protect your interests and loved ones.

Another mistake is thinking an estate plan is a one-and-done affair. Just as people’s lives and fortunes change over time, so should their estate plan. An estate plan created for a young family with small children won’t work for a mature couple with grown children and significant savings.

Change also comes to family dynamics. The same cousin who was like a sister during your teen years may not be as close in values or geography, when you both have elementary school children. Do you still want her to be your child’s guardian? An updated estate plan takes into account the changing relationships within the family, as well as the changing members of the family. A beloved brother-in-law isn’t so beloved, if he divorces your favorite sister. When families change, estate plans need to be updated.

Here is a huge mistake rarely articulated: somehow not thinking about death or incapacity might prevent either event from happening. We know that death is inevitable, and incapacity is statistically probable. Planning for both events in no way increases or decreases their likelihood of occurring. What planning does, is provide peace of mind in knowing you have prepared for both events.

No one wants to be in a nursing home but telling loved ones you want to remain at home “no matter what happens” is not a plan for the future. It is devastating to move a loved one into a nursing home. However, people with medical needs need to be there to receive proper care and treatment. Planning for the possibility is better than a family making arrangements, financial and otherwise, on an emergency basis.

Do you remember that all-knowing family member described in the start of this article? Their advice, however well-intentioned, can be disastrous. Alternatives to estate planning take many shapes: putting the house in the adult child’s name or adding the adult child’s name to the parent’s investment accounts. If the beneficiary has a future tax liability, debt or divorce, the parent’s assets are there for the taking.

Properly done, with the guidance of an experienced estate planning attorney, your estate plan protects you and those you love, as well as the assets you’ve gained over a lifetime. Don’t fall for the idea of “simple” or back-door alternatives. Formalize your goals, so your plans and wishes will be followed.

Reference: The News-Enterprise (Aug. 24, 2021) “Misinformation, poor assumptions result in major planning mistakes”

A Trust can Protect Inheritance from Relatives

“You may love your son-in-law or daughter-in-law now, but that could change down the road. So, if you don’t want your money going to your child’s future ex, here’s what you should do.”

It’s always exciting to watch adult children build their lives and select spouses. However, even if we adore the person they love, it’s wise to prepare to protect our children, says a recent article titled “Worried about Your Child’s Inheritance If They Divorce? A Trust Can Be Your Answer” from Kiplinger.

After all, why would you want the assets and money that you accumulated over a lifetime to pass to any ex-spouse, if a divorce happens?

With the current federal estate tax exemptions still historically high (although that may change in the near future), setting up a trust to protect wealth from federal estate taxes isn’t the driving force in many estate plans. The bigger concern is how well your children will do, if and when they receive their inheritance.

Some people recognize that their children are simply not up to the task. They worry about potential divorces, or a spendthrift spouse. The answer is estate planning in general, and more specifically, a well-designed trust. By establishing a trust as part of an estate plan, these assets can be protected.

If an adult child receives an inheritance and commingles it with assets owned jointly with their spouse—like a joint bank account—depending upon the state where they live, the inheritance may become a marital asset and subject to marital property division, if the couple divorces.

If the inheritance remains in a trust account, or if the trust funds are used to pay for assets that are only owned in the child’s name, the inherited wealth can be protected. This permits the child to have assets as a financial cushion, if a divorce should happen.

Placing an inheritance in a trust is often done after a first divorce, when the family learns the hard way how combined assets are treated. Wiser still is to have a trust created when the child marries. In that way, there’s less of a learning curve (not to mention more assets to preserve).

Here are three typical situations:

Minor children. Children who are 18 or younger cannot inherit assets. However, when they reach the age of majority, they can. A sudden and large inheritance is best placed in the hands of a trustee, who can guide them to make smart decisions and has the ability to deny requests that may seem entirely reasonable to an 18-year-old, but ridiculous to a more mature adult.

Newlyweds. Most couples are divinely happy in the early years of a marriage. However, when life becomes more complicated, as it inevitably does, the marriage may be tested and might not work out. Setting up a trust after the couple has been together for five or ten years is an option.

Marriage moves into the middle years. After five or ten years, it’s likely you’ll have a clearer understanding of your child’s spouse and how their marriage is faring. If you have any doubts, talk with an estate planning attorney, and set up a trust for your child.

Estate plans should be reviewed every four or five years, as circumstances, relationships and tax laws change. A periodic review with your estate planning attorney allows you to ensure that your estate plan reflects your wishes.

Reference: Kiplinger (April 16, 2021) “Worried about Your Child’s Inheritance If They Divorce? A Trust Can Be Your Answer”

 

A Trust can Protect Inheritance from Relatives

“You may love your son-in-law or daughter-in-law now, but that could change down the road. So, if you don’t want your money going to your child’s future ex, here’s what you should do.”

It’s always exciting to watch adult children build their lives and select spouses. However, even if we adore the person they love, it’s wise to prepare to protect our children, says a recent article titled “Worried about Your Child’s Inheritance If They Divorce? A Trust Can Be Your Answer” from Kiplinger.

After all, why would you want the assets and money that you accumulated over a lifetime to pass to any ex-spouse, if a divorce happens?

With the current federal estate tax exemptions still historically high (although that may change in the near future), setting up a trust to protect wealth from federal estate taxes isn’t the driving force in many estate plans. The bigger concern is how well your children will do, if and when they receive their inheritance.

Some people recognize that their children are simply not up to the task. They worry about potential divorces, or a spendthrift spouse. The answer is estate planning in general, and more specifically, a well-designed trust. By establishing a trust as part of an estate plan, these assets can be protected.

If an adult child receives an inheritance and commingles it with assets owned jointly with their spouse—like a joint bank account—depending upon the state where they live, the inheritance may become a marital asset and subject to marital property division, if the couple divorces.

If the inheritance remains in a trust account, or if the trust funds are used to pay for assets that are only owned in the child’s name, the inherited wealth can be protected. This permits the child to have assets as a financial cushion, if a divorce should happen.

Placing an inheritance in a trust is often done after a first divorce, when the family learns the hard way how combined assets are treated. Wiser still is to have a trust created when the child marries. In that way, there’s less of a learning curve (not to mention more assets to preserve).

Here are three typical situations:

Minor children. Children who are 18 or younger cannot inherit assets. However, when they reach the age of majority, they can. A sudden and large inheritance is best placed in the hands of a trustee, who can guide them to make smart decisions and has the ability to deny requests that may seem entirely reasonable to an 18-year-old, but ridiculous to a more mature adult.

Newlyweds. Most couples are divinely happy in the early years of a marriage. However, when life becomes more complicated, as it inevitably does, the marriage may be tested and might not work out. Setting up a trust after the couple has been together for five or ten years is an option.

Marriage moves into the middle years. After five or ten years, it’s likely you’ll have a clearer understanding of your child’s spouse and how their marriage is faring. If you have any doubts, talk with an estate planning attorney, and set up a trust for your child.

Estate plans should be reviewed every four or five years, as circumstances, relationships and tax laws change. A periodic review with your estate planning attorney allows you to ensure that your estate plan reflects your wishes.

Reference: Kiplinger (April 16, 2021) “Worried about Your Child’s Inheritance If They Divorce? A Trust Can Be Your Answer”

 

What Is Family Business Succession Planning?

“If you plan to pass your business to your offspring, there is more to keep in mind when creating your succession plan than your descendants—there are also their spouses—especially if they become ex-spouses.”

Many family-owned businesses have had to scramble to maintain ownership, when owners or heirs were struck by COVID-19. Lacking a succession plan may have led to disastrous results, or at best, less than optimal corporate structures and large tax bills. This difficult lesson is a wake-up call, says the article “Succession Planning for the Family-Owned Business—Keepin’ it ‘All in the Family’” from Bloomberg Tax.

Another factor putting family-owned businesses at risk is divorce. Contemplating the best way to transfer ownership to the next generation requires a candid examination of family dynamics and acknowledgment of outsiders (i.e., in-laws) and the possibility of divorce.

Before documents can be created, a number of issues need to be discussed:

Transfer timing. When will the ownership of the business transfer to the next generation? There are some who use life-events as prompts: births, marriages and/or the death of the owners.

How will the transfer take place? Corporate structures and estate planning tools provide many options limited only by the tax liabilities and wishes of the family. Be wary, since each decision for the structure may have unintended consequences. Short and long-term strategic planning is needed.

To whom will the business be transferred? Who will receive an ownership interest and what will be the rights of ownership? Will there be different levels of ownership, and will those levels depend upon the level of activity in the business? Will percentages be used, or shares, or another form?

In drafting a succession plan, it is wise to assume that the future owners will either marry or divorce—perhaps multiple times. The succession plan should address these issues to prevent an ex-spouse from becoming a shareholder, whose interest in the business needs to be bought out.

The operating agreement/partnership agreement should require all future owners to enter into a prenuptial agreement before marriage specifically excluding their interest in the family business from being distributed, valued, or deemed marital property subject to distribution, if there is a divorce.

An owner may even exact a penalty for a subsequent owner who fails to enter into a prenup prior to a marriage. The same corporate document should specifically bar an owner’s spouse from receiving an ownership interest under any circumstance.

A prenup is intended to remove the future value of the owner’s interest from the marital asset pool. This typically requires the owner to buy-out the future spouse’s legal claim to future value. This could be a costly issue, since the value of the future ownership interest cannot be predicted at the time of the marriage.

Many different strategies can be used to develop a succession plan that ideally works alongside the business owner’s estate plan. These are used to ensure that the business remains in the family and the family interests are protected.

Reference: Bloomberg Tax (April 5,2021) “Succession Planning for the Family-Owned Business—Keepin’ it ‘All in the Family’”

Estate Planning Lessons from Celebrity Nightmares

“The press has made much of the handwritten will that Larry King executed in the months before he died and in which he purports to change his prior will executed in 2015, to leave his estate equally between his children.”

The dispute over Larry King’s estate shines a harsh spotlight on what happens when an elderly person makes major changes late in life to his or her estate plan, especially when the person has become physically weakened and possibly mentally affected, due to aging and illness. A recent article from The National Law Journal, “Larry King Will Contest—Key Takeaways,” examines lessons to be learned from the Larry King will contest.

A handwritten will is most likely to be probated. King’s handwritten will was witnessed by two individuals and may rise to the standards of California’s rules for probate. California was likely King’s residence at the time of his death. However, even if King’s won’t satisfy one section of California estate law referring to probate, it appears to satisfy another addressing requirements for a holographic will.

Holographic will requirements vary from state to state, but it is generally a will that is handwritten by the testator and may or may not need to be witnessed.

The battle over the will is just a starting point. Most of King’s assets were in revocable trusts and will be conveyed through the trusts. He did not seek to revoke or amend the trusts before he died. News reports claim that the probate estate to be conveyed by the will is only $2 million, compared to non-probate assets estimated at $50 million—$144 million, depending upon the source.

Passing assets through trusts has the advantage of keeping the assets out of probate and maintaining privacy for the family. The trust does not become a matter of public record and there is no inventory of assets to be filed with the court.

Any pre- or post-nuptial agreements will have an impact on how King’s assets will be distributed. This is an issue for anyone who marries as often as King did. Apparently, he did not have a prenuptial agreement with his 7^th wife, Shawn Southwick King. They were married for 22 years and separated in 2019. While Larry had filed for divorce, the couple had not reached a financial settlement. California is a community property state, so Southwick will have a legal claim to 50% of the assets the couple acquired during their long marriage, regardless of the will.

It is yet unclear whether there was a post-nuptial agreement. There are reports that the couple separated in 2010 after tabloid reports of a relationship between King and Southwick’s sister, and that there was a post-nuptial agreement declaring all of King’s $144 million assets to be community property. Southwick filed for divorce in 2010, and King sought to have the post-nup nullified. They reconciled for a few years and King was reported to have updated his estate plan in 2015.

The claim of undue influence on the will may not be easy to challenge. Southwick is claiming that Larry King Jr., King’s oldest son, exerted undue influence on his father to change the will. They were not close for most of Larry Jr.’s life, but in the later years of his life, King made a transfer of $250,000 to his son. Southwick wishes to have those transfers set aside on the basis of undue influence. She claims that when King executed his handwritten will, he was highly susceptible to outside influences and had questionable mental capacity.

Expect this will contest to continue for a while, with the possibility that the probate court dispute extends to other litigation between King’s last wife and his oldest son.

Reference: The National Law Review (March 15, 2021) “Larry King Will Contest—Key Takeaways”

Planning Future for Nontraditional Families

“Some people are concerned that the new conservative 6-3 majority on the Supreme Court will roll back protections for non-traditional families. Regardless of the decisions at the Supreme Court, or the impact on the state family courts, there are many ways that non-traditional families can maintain control.”

Today’s non-traditional family are not just LGBTQ couples, but families undergoing gray divorces, blended families, stepchildren, multinational families and children born through assisted reproductive technologies, referred to as ART, in a recent article titled “How to Plan for LGBTQ, Blended Families, Cohabitation, Other Nontraditional Families” from Financial Advisor.

The key is having an estate plan prepared that is flexible so that last wills, trusts, and all documents reflect the non-traditional family very clearly and do not leave room for courts to make decisions. Here are a few new elements to consider:

Gendered pronouns and definitions. Ideally, your estate documents should use specific names of individuals, not pronouns. We live in a fluid society and using pronouns could lead to unnecessary complications.

Recognize ART and its implications. If there are children conceived by ART, they need to be explicitly included as children of the family. DNA testing can result in a child inheriting assets from a parent they never knew. It may be wise to exclude biological children, parents or siblings who do not have a relationship with the family.

Trust Protector/Trust Decanting. By including provisions that permit trusts to be decanted, that is, transferred from one trust to another, your estate planning attorney will create flexibility to allow a trust protector (a non-fiduciary appointment of a third party) to make changes. The selection of the trust protector is particularly important, as they could have a large impact on the overall plan.

Marriage, non-marital relationships, divorce, remarriage. An estate plan needs to prepare for future changes with precision and flexibility. Protecting the family, its privacy and dignity can be done by limiting the information in the last will, which becomes a public document. While we can’t know what the future holds, we can plan for change.

Prenuptial agreements. State laws vary on what is acceptable and procedurally necessary for a prenup to be enforceable. Typically, the agreement must be voluntary and include full disclosure of both parties’ financial situation. In some states, post-nuptials can be prepared, if the parties can’t agree on the document before they are legally wed.

Divorce creates special estate planning issues. Beneficiary designations need to be changed for life insurance, IRAs and other non-probate assets. Take affirmative steps to ensure that ex-spouses, or soon-to-be exes are removed as beneficiaries on all accounts, including pensions and insurance plans subject to ERISA.

Cohabitating couples. Marital gifts are tax free, but that is not the case for people living together. Estate planning and tax planning needs to be done, so the surviving partner is taken care of. This may include the creation of a cohabitation agreement, similar to a prenuptial agreement.

Planning for sickness and death. Explicitly stating wishes for end-of-life medical treatments, including feeding tubes, respirators, heart machines, etc., is step one in having an Advance Medical Directive created. Step two is deciding who is empowered to make those decisions. Someone who is unmarried but has a partner or a second spouse needs to be authorized. Note that when an individual is hospitalized, stepparents may attempt to deny access to spouses’ children, or children may block access to a stepparent. There should also be a Do Not Resuscitate (DNR) or Physicians Orders for Life-Sustaining Treatment (POLST) in place with the person’s wishes.

Non-traditional families of all types need to protect the family with estate planning and documentation. Issues about protecting children, making health care decisions for a critically ill partner and control of assets must be addressed in a way that respects the individuals and their families while working within the law.

Reference: Financial Advisor (Feb. 2, 2021) “How to Plan for LGBTQ, Blended Families, Cohabitation, Other Nontraditional Families”

Divorce, Death and Details: Missteps can Create Estate Planning Disasters

“After the divorce, Mike logged onto the employer’s benefits system and tried, but failed, to delete Wendy as the beneficiary of his life insurance.”

This estate battle shows how small details can become huge headaches. Four courts and several years after this estate battle began, a family won a case that could have been easily prevented, as reported in The Dallas Morning News article “The way out of the ERISA trap: A tale of divorce, death and money.”

A couple married and then divorced. The divorce decree clearly stated that Mike was awarded all of his employee benefits, including his life insurance. However, when Mike logged into his employer’s benefits systems, it would not allow him to delete his ex-wife as the beneficiary of his life insurance. It may have been programmed that way. There are laws concerning removing spouses from employee benefits. Or it was a glitch. However, Mike did not pursue it.

When Mike died, he was survived by his parents, who claimed his estate, but the $377,000 life insurance policy was not part of his estate because his ex-wife was still the beneficiary.

His parents filed a claim with the insurance company for the proceeds of the insurance policy.

The first court they filed in was the probate court, so they could be properly recognized as Mike’s heirs. The probate court found in their favor and named Mike’s dad as the independent administrator of his estate.

The second court was federal court. That’s because employee benefits are governed by a federal law ERISA—the Employee Retirement Income Security Act—that controls employee benefits, including employer-provided life insurance. These matters can only be dealt with by a federal court.

The federal court ruled that because Mike’s ex was on the beneficiary form, she was the rightful owner.

However, Wendy had waived her rights to the insurance benefits when she signed off on the divorce decree. Mike’s parents were determined to win this battle.

Their legal team took the argument next to court three—the original divorce court. Mike’s dad, in the position of the estate administrator, argued that while Wendy did have a right to receive the money under ERISA, she did not have a right under state law to keep it. She had waived that right in the divorce decree. The divorce court agreed and found that Mike’s estate owned the proceeds. The money was to be turned over to Mike’s parents.

Court number four came when Wendy petitioned the state appellate court to overturn the award. She lost.

What were the factors that allowed Mike’s parents to win this case? The divorce decree contained clear language regarding the life insurance policy. If it had been poorly drafted, the results could have been different. Mike’s parents went through all the correct procedural courts—establishing heirship, then probate, then divorce enforcement case.

One step could have been added: a restraining order so that the ex could not squander the money between the time that she received the proceeds and when the final judgement was rendered.

Reference: The Dallas Morning News (Jan. 24, 2021) “The way out of the ERISA trap: A tale of divorce, death and money”

Are Retirement Accounts Divided in a Divorce?

“Gray divorce issues include weaving through the complications of splitting pensions, 401(k)s and more before the process is complete.”

Divorce is different for older couples. They must focus on retirement accounts instead of college savings plans, explains a recent article from Kiplinger titled “Considering Divorce? Beware of Retirement Account Breakups.” After retirement accounts, the marital home is usually the second largest asset.

Older couples with separate retirement accounts often combine the balances to divide them, along with any other savings accumulated during the couple’s lifetime. However, IRAs, 401(k)s and pensions are complicated financial tools and there are equally complex rules as to how the accounts are divided. Transferring retirement funds to a former spouse can have large tax consequences, if they are not done correctly.

Couples should have their matrimonial attorneys work with an estate planning attorney to protect their retirement funds from any mishaps. A qualified domestic relations order, or QDRO, is needed to transfer a 401(k) or pension rights in a divorce. The QDRO is issued by a court or state agency and recognizes the divorcing spouse’s right to receive all or part of a portion of the account owner’s defined contribution plan or pension.

Dividing assets with a QDRO occurs in two different ways. One awards a separate interest in the account balance, and the second permits the divorcing spouse to share in the payment of benefits. Once an agreement is reached, the account owner gives the document to the plan administrator. Drafting a QDRO can be costly, so it is recommended that the plan administrator be asked to provide model QDRO language to ensure that the document aligns with that particular plan’s requirements.

A 401(k) is easier to divide. Once the couple has negotiated who is getting what, the monies can be transferred to the other spouse’s IRA, with no federal income taxes or penalties. However, if the spouse receiving the money takes the money directly and it does not go by direct transfer, then income taxes will be owed. There won’t be a 10% penalty for early distribution, as long as the QDRO is correctly prepared. Once the money is transferred from one spouse to another’s IRA, then early withdrawals will require the payment of income taxes and a 10% penalty.

Pensions are more complicated. Each employer plan has different rules for dividing up a pension, and an actuary is needed to determine present value of future benefits to ensure a fair distribution. It’s easier to split a pension when the pensioner spouse has already begun taking benefits. In that case, the QDRO can be used to divide payments by a dollar or percentage amount.

There is no need for a QDRO for dividing an IRA. The terms for the division of the accounts must be specified in the divorce or separation agreement, which the account owner must provide to the IRA sponsor. If the money is to be divided with no taxes or penalties, the agreement must specify that a percentage or dollar amount of the account owner’s balance goes to the spouse’s IRA in a direct trustee-to-trustee transfer. The language matters to avoid taxes and penalties.

If the receiving spouse decides to take cash out in the transfer, they will still owe taxes on the withdrawal. If they are younger than 59 ½, they’ll also owe a 10% penalty. In the same way, the account owner who takes money from the IRA to give to a spouse in a divorce will have to pay taxes on the payout and the 10% penalty, if they are under age 59 ½.

Reference: Kiplinger (Jan. 4, 2021) “Considering Divorce? Beware of Retirement Account Breakups”