Questions About Profit Sharing Plans and Divorce

If you have questions about profit sharing plans and how they are affected by divorce, the following information can help you understand how everything is handled.

Belinda's Question: My divorce settlement says that I will receive 1/2 of my husband's retirement when he retires, and states a specific amount. It has only been a few months since the divorce was final, and he is about to lose this job. How can I ensure I will receive this money? It is a "profit sharing plan" that he didn't pay any money into. It is with a family-owned business. We live and divorced in Texas and this company is based in Chicago, IL.

Timothy's Answer: A Profit Sharing Plan is an agreement between employers and employees that allows employees to share in the profits of the company. In this type of program, your husband's company has flexibility in determining the amount and when contributions are made to the plan. This money is then allocated between individual accounts, typically based on an employee's salary level.

At your husband's employer's discretion and when the company has a profitable year, his employer can make a contribution to each employee's profit-sharing account. These funds can then be used to invest in stocks, bonds or other investment vehicles on a tax-deferred basis.

Most profit sharing plans are designed so that contributions become vested over a set period of time, usually between 3 and 6 years (some longer) before an employee is eligible to receive benefits. If your husband lost his job or left the company for any reason prior to him becoming fully vested, he would forfeit all or a percentage of his plans accumulated value. Whether or not your husband keeps his job, if the finalized settlement agreement stipulates that you're to receive half of the profit sharing account, you'll be entitled to it, as long as he has satisfied the vesting requirements. While you state your husband has not actually contributed any of his own funds to his plan, if his company has made contributions to his plan and he is partially or fully vested, then his profit sharing plan has some value.

Profit sharing plans, unlike IRA's are considered "qualified plans" and hence fall under the guidelines of the Employee Retirement Income Securities Act of 1974 (ERISA). This act established minimum standards for private industry pension plans to protect the assets of workers participating in these plans. Over time important legislation has amended ERISA. The Retirement Equity Act of 1984 among other things, created spousal rights to pension benefits through qualified domestic relations orders (QDRO's) in the event of divorce.

How profit sharing plans are divided in divorce

Today, the only way to divide your husband's profit sharing plan is with the use of a QDRO. This is a legal order which allows a retirement plan to name someone other than the plan holder as an alternative payee, who can then to receive payments from the plan. Only spouses, ex-spouses, or children of the plan holder may be named as an alternate payee. If you used an attorney for your divorce, he/she would have had this document prepared for you either in-house or by an outside expert.

Many attorneys shy away from preparing QDRO's because often they are very complex and most people, attorneys included, do not fully understand them. If you used an attorney, you should speak to him or her to inquire about this. Your QDRO would have been filed with the court and you need this to get access to your one-half of your settlement. The fact that you live in Texas and his company is Chicago based does not matter. This would not have any effect on your settlement or your share of his profit sharing plan.

You will want to establish a rollover IRA to receive your portion of the profit sharing settlement in order to avoid having to pay taxes and possibly a penalty by taking a distribution before you are 59½. However, in certain situations you can make distributions which would allow you to avoid the age-59½ penalty tax.

Timothy McNamara Financial Analyst

Related Information:

If you still have questions about profit sharing plans, the BalanceMoney provides good background information in their article: Profit-Sharing Plans Explained.

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