A 401(k) is a tax-qualified retirement plan sponsored by an employer and defined in subsection 401(k) of the Internal Revenue Code. This defined contribution savings plan allows employees to invest a percentage of their paycheck before they are taxed on the income, often with an employer contributing a matching percentage up to a certain amount. This lets employees defer their tax liability until later in life when the money is withdrawn.
Like an Individual Retirement Account (IRA), there is a cap on the amount of money you can contribute to a 401(k) in a year. Additionally, there are costly penalties for withdrawing money prior to retirement. The attractive tax benefits offered to 401(k) participants, however, provide a powerful incentive for employees to participate despite the potential drawbacks.
Like other retirement accounts, how an individual 401(k) will be divided upon divorce is often a concern to the parties. Even if it was opened prior to marriage, a 401(k) is still considered to be community property to the extent that it accrued during the marriage.
Because a 401(k) is a type of defined contribution plan, §3007(c) of the Texas Family Code is applicable to determine the value of the community’s interest in it. This section of the Family Code defines a spouse’s separate property interest by providing that it be traced using the same tracing and characterization principles that apply to a nonretirement asset. The amount remaining after a spouse’s separate property value has been subtracted is the value to the community estate.
At least one Texas Appeals Court has held that the community interest of a defined contribution plan can be easily determined by subtracting the value of the account at the time of the marriage from the value of the account at the time of the divorce. Although it is permissible to divide the community value of a 401(k) equally between the parties, there is no requirement that this be done.
All that is required by the Texas Family Code is that the division of the entire community estate be just and right. Therefore, it is also acceptable to award the entire value of a 401(k) to the employee spouse as long as the other spouse receives just compensation from the community estate.