“I’m not assuming that I’m getting divorced, but one never knows what might happen tomorrow.” (Photo subjects are models.) – Getty Images/iStockphoto
My husband and I live in Arizona, which from my understanding is a community-property state. We moved here eight years ago from Illinois. I’m about to get money from a late relative’s trust. We want to invest the money and play catch-up with our retirement savings/funding.
I’m not assuming that I’m getting divorced, but one never knows what might happen tomorrow. I love my husband and have no plans to get divorced, but should the unfortunate happen, what do I need to do when investing this money to ensure that I am entitled to every last penny?
In Arizona, as in many states, an IRA is considered community property, while an employer-sponsored 401(k) is treated as separate property. – MarketWatch illustration
To quote George Bernard Shaw: “You never can tell, sir, you never can tell.”
Arizona is indeed a community-property state, meaning that everything you acquire prior to the marriage is separate property, as are inheritance and gifts acquired during the marriage. And you’re correct again: It does not harm to have “FU” money — as in, “financially unattached” money. (What did you think the “FU” stood for?) And you are on the mark for the third time: You need to keep this money separate and not commingle it with your husband’s finances. For that reason, you should be careful about commingling the inheritance with your IRA and/or 401(k).
Alternatively, you could invest the inheritance you expect to receive in a separate brokerage account in your name only. If you feel confident about U.S. equities, you could also invest a portion of your inheritance in a mutual fund or an exchange-traded fund that tracks the stock market, the S&P 500 SPX or another diversified index (perhaps the Vanguard Total Stock Market ETF VTI). Remember the “d”-word: diversification. You can mix up your choice of ETFs and broaden your horizons further. You can read more about diversification here.
As for your retirement funds? “All marital assets acquired during a marriage are considered jointly owned by both spouses. In the context of a 401(k), this applies to any contributions made to the account, as well as any growth on those contributions, during the marriage,” according to Clark & Schloss Family Law in Scottsdale, Ariz. “For example, if you had a 401(k) with a $10,000 balance before you got married, and during the marriage, the balance grew to $50,000 due to your contributions and investment gains, the increase of $40,000 would be considered community property.”
For that reason, you should be cautious about putting money into your retirement accounts. This is where your inheritance could come unstuck if you did, as that George Bernard Shaw quote implies, get divorced. In Arizona, as in many states, an IRA is considered community property, while contributions made to an employer-sponsored 401(k) before the marriage is treated as separate property, but valued accrued during the marriage is community property. When couples divorce, 401(k) accounts are usually split through a qualified domestic relations order, or QDRO.
Not so for IRAs. “When dividing the assets, the receiving spouse may choose to take the money as a distribution or roll it over into their own retirement-plan account, such as an IRA,” says Merrill Edge, an investment-advisory service. “The typical additional tax for early withdrawal does not apply to distributions made pursuant to a QDRO, but the receiving spouse would still owe federal and, if applicable, state income taxes on the distribution.”
Rules regarding 401(k)s are set by the Employee Retirement Income Security Act, which sets standards for private-sector retirement and health plans. Here is what the U.S. Labor Department says on the subject: “In most 401(k) plans and other defined-contribution plans, the plan is written so different protections apply for surviving spouses. In general, in most defined-contribution plans, if you die before you receive your benefits, your surviving spouse will automatically receive them.”
But here’s the twist for anyone who plans to divorce: “If you wish to select a different beneficiary, your spouse must consent by signing a waiver, witnessed by a notary or plan representative,” the agency notes. “If you were single when you enrolled in the plan and subsequently married, it is important that you notify your employer and/or plan administrator and change your status under the plan.” So be careful where you put your inheritance.
“With community property a spouse could claim an interest in the community property, even if it was held in an IRA in the name of the other spouse,” says George Bearup, senior legal trust adviser at Greenleaf Trust. “This would be a 50% interest in the IRA, even though it is held in the sole name of the other spouse, and even though the other spouse contributed 100% to the IRA during the marriage. Usually, the former spouse’s community-property interest in the IRA can be transferred to his/her own IRA in a custodian-to-custodian transfer without any income tax consequences to the IRA owner.”
I wish you many years of happy investing and marriage.
