March 6, 2023
When splitting retirement accounts, we have the choice of dividing an account by shares or by value. The wording is important; if not worded correctly there can be problems down the road. This is primarily because of the time lag between finalizing the terms of the divorce and effectively dividing the accounts. IRAs can be split pretty quickly since the custodian needs only the divorce decree and letter of instruction. But 401(k)s and other company retirement accounts need a QDRO, which can take months to secure. By then the account value may have changed significantly.
As an example, Mark has agreed to give Kelly half of his 401(k) in the divorce agreement. The word “half” itself tells us very little. Is it half of the value on a specific date, or half on the date the custodian receives the instructions? Does it include contributions or earnings after the date of the decree (or an otherwise noted date)? Does it include gains and losses?
At the very least the decree should specify a date to apply the instructions. Using a month-end date allows all parties to verify the split amount because a monthly statement will show the value and the shares in the account.
Let’s assume the couple agreed that the account is to be split using a March 31st value. The account is worth $100,000 on that date.
If we are awarding value, the decree might say as “Kelly receives half of Mark’s 401(k) as of March 31st.” Since the account was worth $100,000 on that date then Kelly is to receive $50,000. If the account value goes down before the division is made then either Mark may not have enough money in the account to give Kelly $50,000 – he may have to pull money from another account - or he may have to give Kelly a bigger portion of the account than he intended. Also, because the account value went down any contributions Mark made to the account after the divorce was finalized, but before the account was split, would be included in the portion due to Kelly.
You could add the words “including gains and losses and earnings” which would have spared Mark but put Kelly at risk, because Kelly would share in the loss of value. On the flip side, if the account goes up or earns some interest, Kelly would get a share of that. In both situations you are deviating from giving her exactly $50,000.
If the wording is “shares” then Kelly gets 50% of the shares. In this case the decree could say “Kelly receives 50% of the shares in Mark’s 401(k) as of March 31st”. If the markets decline and the account goes down to $80,000 the shares would be worth less but Mark would not owe her any additional shares. In addition, Mark’s contributions after March 31st remain his, as do any interest, dividends or capital gain distributions. Adding the words “including gains and losses and earnings” helps reduce the risk for both parties.
In most situations awarding shares, and not value, fits the situation. In cases where a specific dollar amount is intended to be awarded then “value” may be applicable.