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Does equitable distribution case law overvalue retirement accounts?

Individual Retirement Accounts (IRA) and 401k account assets are not as valuable as an equivalent amount of cash.  With some exceptions there is a 10% penalty for withdrawing from such accounts prior to the account holder turning age 59 ½.  Other than Roth-IRAs these accounts are also subject to income tax when funds are withdrawn.  For equitable distribution purposes, given a choice between a liquid asset or an equivalent amount of retirement, one should prefer the liquid asset.

The equitable distribution statute would appear to allow the court to take these consequences into consideration.  S.C. Code Ann. § 20-3-620 (B)(11) specially states the family court “must give weight” to “the tax consequences to each or either party as a result of any particular form of equitable apportionment.”

Until recently, I had always assumed that, if asked, the family court could and would reduce the real value of retirement assets in doing equitable distribution to take account of these tax consequences.  Last month I was mediating a case in which my client, the husband, had substantial retirement accounts while the parties owned a home with substantial equity.  Everyone wanted wife to keep the home.  However this meant that husband would get a majority of the retirement account to balance wife keeping all the home equity.  Whether to value the retirement account at 100% of its account balance or whether to apply some discount for taxes was an issue under my consideration.

Or at least it was until my own financial expert, Cindy MacAulay of Dixon Hughes Goodman LLP, taught me some family law.  She informed me there was case law holding that one could not discount retirement accounts that were not intending to be liquidated in equitably dividing them, despite the inevitable tax consequences.  And, indeed, she was correct: the case of Bowers v. Bowers, 349 S.C. 85, 561 S.E.2d 610 (Ct.App.2002), specifically states:

We further find no error in the Family Court’s failure to expressly consider tax consequences resulting from its award to Wife of one-half the value of Husband’s 401(k) account.  Where an order of equitable apportionment does not contemplate the liquidation or sale of an asset, it is an abuse of discretion for the court to consider the tax consequences from a supposed sale or liquidation.

Bowers cites to the case of Ellerbe v. Ellerbe, 323 S.C. 283, 473 S.E.2d 881 (Ct.App.1996), where the Court of Appeals reversed the family court for discounting retirement accounts based on tax consequences in its equitable distribution award when no immediate liquidation was contemplated.

A similar, and unsuccessful, argument has been attempted regarding valuations of the marital home, with the party keeping the home arguing that the value should be discounted for the expected costs of selling the home even if it is not contemplated that the home will be sold.  For homes I agree the financial consequences of liquidating a home shouldn’t be considered in valuation (unless the home is being sold) because the home has value without being liquidated: one can live in it or one can rent it and keep the rental proceeds.  However retirement accounts only have utility once they are liquidated and, upon liquidation, income taxes (and sometimes penalties) need to be paid.

Retirement accounts are one asset in which taxes consequences occur upon liquidation and in which liquidation is almost certain.  While it might be speculative to guess what percentage of the account will end up going to the IRS, even a conservative estimate is more equitable than providing no discount.

As South Carolina case law now stands, I believe it vitiates the legislative intent of S.C. Code Ann. § 20-3-620 (B)(11) and does an injustice to the spouse keeping a majority of the retirement accounts.

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