Hi Victoria,VictoriaF wrote: ↑Thu Dec 06, 2018 8:02 amBilly,BillyG wrote: ↑Wed Dec 05, 2018 5:29 pmHere's an interesting question:

Part of divorce asset valuation involves apples and oranges -- savings accounts, homes, IRAs, ROTH IRA's, real estate etc with different basis calculations and different tax treatment. For assets that are divided in half, it doesn't matter because each party gets half-apples and half-oranges. In trying to convert all of these different asset types into after-tax assets (assets on which no taxes are due such as a regular savings account) that are "apples" for comparison, how would you convert a 401(k) into an after-tax "apple" for comparison to other assets?

For example, if I offer an extra $100K from a 401(k) as part of an up-front payment, my wife's lawyer would say it is worth only $70K after-tax, applying what he says is her 30% income tax rate. I might argue the 30% rate is incorrect because:

1. The calculation should not be done at her current marginal rate.

2. The calculation should reflect the rate that applies when the funds would be withdrawn, which is in retirement at a lower rate.

3. The calculation should not assume the $100K is withdrawn all at once. For example, she could withdraw $39K/year and pay a 12% marginal rate (assuming no other income).

4. We should use a blended rate rather than a marginal rate (assuming no other income, which may not be accurate).

5. This money has additional value in that earnings and growth can accumulate tax deferred. There is value to her of having more tax-deferred space for her retirement investments.

I am open to any comments or observations on this analysis. Does it hold water?

I am particularly interested in how to place a "value" on the tax-deferred earnings/growth aspect of this money in a 401(k). I doubt there is a way to apply a percentage, but it should be worth something. For example, it has value in tax efficient placement of funds that spin off dividends which can accumulate without having to pay annual taxes at a higher tax rate than in retirement.

See tax table below.

Billy

Table 1. Tax Brackets and Rates, 2019

Rate For Unmarried Individuals, Taxable Income Over

10% $0

12% $9,700

22% $39,475

24% $84,200

32% $160,725

35% $204,100

37% $510,300

If your wife's lawyer is applying 30% discount to tax-deferred funds you would give to your wife, you can give your wife money from Roth and apply 40% discount to the tax-deferred funds you keep. The logic should work both ways.

While you treasure your Roth, you may end up with more assets using the strategies you have listed, i.e., not cashing it all at once, waiting for low-income years, etc.

Victoria

I like the way you think! I will use this strategy to propose that I keep $100K in 401(k) funds for each $60K in after-tax funds she keeps...

For now I responded to the 30% tax rate proposal by proposing an 11.5% effective tax rate for this $100K lump sum payment from a 401(k). See below:

Dear lawyer,

We don’t know your assumptions in arguing that 401(k) money should be devalued by 30% if it is part of a lump sum settlement offer, but it appears you assume the money would be withdrawn from the 401(k) all at once in a lump sum, and that you would apply a 30% tax rate, which we assume is a marginal tax rate. Considering the up-front payment of $100K from Billy’s 401(k), you argue it is worth only $70K after-tax after applying a 30% income tax rate. The assumption all the money is withdrawn at once (while she is still working) and the 30% rate assumption are incorrect for a number of reasons outlined below. Further below we copied the 2019 IRS tax rates for use in our explanation.

1. Even if we use your assumption the 401(k) money would be withdrawn all at once, the 30% tax rate is incorrect. Using the tax tables below, the effective rate is calculated as ($9700 x 10%) + ($29,775 x 12%) + ($44,725 x 22%) + ($15,800 x 24%) => ($970 + $3573 + $9839.5 + $3792)/$100,000 = $18,174.50/$100,000 =

**18.17%**. This is almost half the proposed 30% tax rate, and this is in a scenario where the entire $100K is withdrawn in one year; a scenario that is highly unlikely to occur, and as a tax lawyer we doubt you would recommend this to a client.

2. There is no need to withdraw 401(k) or IRA money (assuming your client rolls this into an IRA she controls) until a person is 70-1/2 years old. It is likely she will not be working and generating taxable income at that time.

3. The 401(k) money would not be withdrawn all at once in a lump sum. Typically it is withdrawn in retirement in smaller chunks over time to generate retirement income, with tax considerations in mind. For example, in retirement your client could withdraw $39K/year from a 401(k) and it would be subject to a 12% marginal tax rate. The actual tax rate is even lower, and referring to the tax table below it would be ($9700 x 10%) + (29,300 x 12%) => $4486/$39000 =

**11.5%**. This number is almost 1/3 the 30% assumption – far less than the 30% assumption, and it would not be applied to the invested money until many years in the future. This is the most likely scenario in which this money would be withdrawn.

4. This money has additional value in that earnings and growth can accumulate tax deferred. This is one of the primary benefits of a 401(k) and it should be recognized, particularly considering that earnings on after-tax regular investments is subject to annual taxes that would devalue this money compared to 401(k) investments. In addition there is value to your client of having more tax-deferred space for her retirement investments. We cannot place a percentage or dollar value on these advantages, and there are benefits that should be recognized in having this money invested in a 401(k) or IRA.

**Table 1. Tax Brackets and Rates, 2019**

Rate For Unmarried Individuals, Taxable Income Over

Rate For Unmarried Individuals, Taxable Income Over

10% $0

12% $9,700

22% $39,475

24% $84,200

32% $160,725

35% $204,100

37% $510,300

We propose the $100K in 401(k) money be valued using an effective tax rate of at most 11.5%; this rate should be even lower recognizing the value of a tax deferred account, particularly when used in conjunction with other accounts for the tax-efficient placement of investments. Using an 11.5% rate results in a valuation of $100K x 88.5% = $88,500 for this money.

Billy