Deferred Compensation in Divorce

Property division can be challenging during a divorce, especially when couples argue about marital and non-marital property. When you add the unique challenges of dividing deferred compensation accounts to the mix, property division can become highly complex. Most people quickly realize they need the assistance of an Illinois divorce attorney to avoid making costly mistakes when attempting to divide deferred compensation accounts during a divorce action.

What is a Deferred Compensation Account?

Employers may withhold a portion of an employee’s income to be paid to the employee at a future date, such as when the employee leaves the company or at retirement. Deferred compensation accounts have several tax benefits depending on whether the account is a qualified account or a non-qualified account. In either case, most employees use the accounts as a way to plan for retirement.

ERISA rules and requirements govern qualified deferred compensation accounts. Most pension plans, 403(b) plans, and 401(k) accounts are qualified deferred compensation accounts.

Non-qualified plans or golden handcuff plans do not fall under ERISA guidelines, but they could be considered a marital asset subject to property division just the same. Stock options, Top Hat Plans, Excess Benefit Plans, and Supplemental Executive Retirement Plans are types of non-qualified deferred compensation accounts.

Because a non-qualified account does not need to be held in trust, an account may not be funded with investments to ensure future distribution, and it is not protected from the employer’s creditors. Therefore, dividing a non-qualified deferred compensation account can be extremely complicated when there are no guarantees that the employee will receive these benefits.

Dividing Deferred Compensation Assets in a Divorce Action

Illinois is an equitable distribution state. The judge decides what is equitable given the facts and circumstances involved, which does not necessarily mean equal. In most cases, a qualified deferred compensation account such as a 401(k) plan is considered marital property. If the spouse owned the account before marriage, the pre-marital value of the account might be subtracted from the current value of the account before the account is divided.

However, you cannot simply withdraw the funds from the account and pay the spouse whose name is not on the account. Withdrawing funds from the account could result in the payment of taxes and penalties if the withdrawal is not handled correctly. A QDRO (Qualified Domestic Relations Order) is used to split a qualified deferred compensation account. The order establishes the non-owner spouse as an alternate payee so that he or she has the right to receive a portion of the deferred compensation account. When drafted correctly, a QDRO can avoid the tax issues and early withdrawal penalties that could arise when dividing a deferred compensation account.

However, non-qualified deferred compensation accounts may need to be handled differently. As mentioned above, if the account is non-funded, the employee only has the employer’s promise of payment in the future. Therefore, dividing this asset now is problematic because there is no way to know if the spouse will ever receive the compensation. Furthermore, even if the account is funded, you may not be able to divide a golden handcuff account in a divorce action.

In those cases, an order may be required to identify the amounts that a spouse should receive “if, as and when” the employee receives the compensation from the non-qualified deferred compensation plan in the future. The order outlines how the spouse would pay an ex-spouse his or her share of the asset when and if the spouse begins receiving distributions from the account.

You Need an Experienced Illinois Divorce Attorney

The above explanation is a brief summary of some of the issues involved in dividing deferred compensation accounts in a divorce action. Because of the serious tax implications and future income implications of dividing these assets, you should work with an experienced Illinois divorce attorney who understands the legal challenges involved in dividing this type of marital property.

In many cases, a CPA may also be required to ensure compliance with all tax laws and employment-related laws. Your accountant, tax professional, and Illinois divorce attorney can work together to protect your interests in deferred compensation accounts whether you are the owner of the account or not. Contact the Illinois property division attorneys at Goodman Law Firm for professional, competent advice.