Changes in marital status can have a big impact on your retirement planning. Retirement account balances, eligibility for pensions, and even Social Security benefits can all be affected by divorce or death. It’s a common misperception that living singly will be half as expensive as living as a couple. In fact, expenses generally drop only about 20% due to housing, insurance, and other costs.
What can you do now to prepare for the possibility that your marital status may change later on? Let’s take a look at the ways retirement benefits could be affected.
401(k) and IRA Balances
How balances on retirement accounts like 401(k)s and IRAs are handled during divorce varies. Accounts can be awarded all to one spouse, or they can be divvied up.1 If a spouse paid in to a 401(k) before the marriage, those funds would generally be considered part of a separate estate and not subject to the divorce settlement.
If you plan to divide retirement accounts up, it may be wise to divide by percentages instead of by dollar amounts. This is because there is often lag time between when the decisions are made and when the accounts are actually divided. If the market takes a plunge during that lag time, a dollar-amount agreement could severly impact one of the parties or cause the need for additional legal expense. With a percentage division, the division can remain equitable, regardless of market performance.
When funds are left in a retirement account after the owners death, they will be distributed according to the beneficiary designations of the benefactor. Depending on the plan setup, spouses may be able to add remaining 401(k) funds from their deceased spouses’ account to their own 401(k) accounts.2 This is may be easiest and most convenient way to consolidate retirement accounts following the death of one spouse.
Pension Plans
Pensions work a little differently than 401(k) and IRA accounts. When it comes to pensions and divorce, a spouse can either buy out the non-participant spouse or give them a share of the pension benefits. You can decide on a value for the pension through actuarial analysis of all the elements of the pension plan. Actuarial analysis can be complicated, so many people opt for dividing the pension 50/50.
Regarding the death of a spouse, pensions can vary from company to company, but they’re all required to offer payout options. If you have chosen the Life Income option, your pension will last as long as you do, but your spouse will not be eligible for any benefits after your death.3 If you choose the Joint and Last Survivor (J&LS) option, your survivor will also be guaranteed income for the rest of his or her life. The survivor benefits may be less than the full benefits, so when you’re planning for retirement, be sure to know how much you can count on from your spouse’s pension if you survive him or her.
Social Security Benefits
If you were married for at least ten years before you divorce, you can still collect Social Security benefits based on your ex-spouse’s income. Some people slow down divorce proceedings to reach the ten-year mark instead of divorcing at 9 ½ years and losing those benefits.
In the case of death, the surviving spouse can claim 100% of the deceased spouse’s Social Security benefits. When both spouses have been drawing Social Security benefits, the survivor can continue drawing the higher benefit of the two. As you make your retirement plans, consider this scenario. The older spouse with a potentially larger benefit might want to consider holding off as long as possible to start collecting Social Security benefits. By waiting, the older spouse can pass on their higher benefit to the younger survivor in a couple.3
Income Taxes
When death or divorce changes your marital status from married to single, the IRS may want to collect more taxes from you as a single filer. You may be able to minimize the damage by itemizing deductions where only the personal exemption would be reduced.3
For the first two years following the death of a spouse, you can use the filing status “qualifying widow(er) with dependent child” if you have a dependent child and meet other requirements: you haven’t remarried, your child lived in your home for the entire year, and you’ve paid more than half the cost of keeping up your primary residence.4 Talk to your financial and tax advisor about other income strategies that will keep your taxes manageable.
To learn more about how a change in marital status can affect your retirement planning, call one of our Wealth Managers at 1-800-541-7774 or contact us here.
Sources:
1. U.S. News
2. Financial Web
3. Rodgers Associates
4. BankRate
The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice either express or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.
