People going through a divorce expect to receive a share of marital retirement accounts. Lawyers use Qualified Domestic Relations Orders (QDRO's) to split 401(k), 403(b) or other retirement plans. Can you consider other uses for this retirement plan, including payment of child support arrearages?
Yet, certain retirement plans may provide a tool to accomplish goals in settlement discussions or to resolve back support issues. Usually, a participant is able to borrow against her own the balance in a 401(k) or 403(b). Interest is charged and is paid back by the participant over time into her own account.
A loan from a retirement plan may be possible to:
· Pay down a mortgage, allowing one party to refinance
· Pay off high interest credit card debt
· Pay an outstanding child support arrearage
When used to pay down debt, be careful determining how the balance of the retirement account is split, for only the participant will be repaying the loan. In the first two instances above, perhaps the balance, after considering the loan, should be split. Perhaps the split should not be equal, to offset the loan taken out. Perhaps the non-participant would take on additional credit card debt to offset the amount of the loan needed to be repaid to the retirement plan. You should discuss this with your attorney.
If the loan is not repaid, there may be important negative income tax ramifications and your financial advisor can help you determine those effects. The rate of the loan may be favorable to other sources of funds. As of August 2013, the average interest rate is about 4.25% (most plans add 1% to the prime rate, though the formula varies across plans). Personal loans and credit cards average 11.4% and 15.3% respectively.
Fidelity Investments conducted a study of retirement account serial borrowers. They found that repeated borrowings can put a serious dent in long-term savings, so this type of loan should not be taken lightly. In the right situation, it is a good tool to reach a resolution when finances are less than optimal.
Retirement account loans are appropriate for reducing more expensive debt, paying down a mortgage so one party can refinance in just his/her name, paying medical bills and paying back due child support than in paying for vacations and buying luxury items or adult toys. Sometimes, a retirement account loan is the answer to making a divorce settlement work. Even after a QDRO splits a retirement account, one may be able to borrow against the balance to use as a down-payment on a new residence.
Source: One Dip Into a 401(k) Often Leads to Another, by Tara Siegel Bernard, NY Times, August 16, 2013