When a marriage ends in divorce, it’s necessary to settle a number of issues concerning different types of property. Things can get especially tricky when individual retirement accounts (IRAs) are involved. In this case, it pays to know how to transfer an IRA properly—failing to do so could lead to a host of adverse consequences, not to mention tax headaches.
Common Questions About IRAs and Divorce
If you’re going through a divorce, or are about to go through one, you probably have these questions about IRAs:
What happens to assets like IRAs?
How are they divided?
When transferring or splitting funds in an IRA, who is responsible for taxes?
According to Section 408(d)(6) of the Internal Revenue Code, the transfer of a person’s interest in an IRA to his spouse or former spouse is done under a “divorce or separation instrument” and is a non-taxable transfer.
For qualified retirement plans, on the other hand, when a transfer is made to a former spouse after a divorce, the person’s interest in the plan at the time of the transfer is considered an account of the former spouse.
In other words, the spouse who transfers retirement assets is not liable for any taxes or penalties from future distributions. The spouse who receives the assets, however (i.e. when the plan becomes their own IRA), will be responsible for taxes and penalties from future distributions.
Are All IRA Transfers Tax-Free?
But not all IRA transfers are automatically tax-free. According to the Internal Revenue Service, spouses must present a number of documents, as defined in Section71(a)(2) of the IRC:
A final decree of divorce
A decree of “separate maintenance”
Or a document or written instrument incident to such decree
A decree of divorce is also known as a “judgment of dissolution.” A divorce decree may also come with an order to divide the IRA as part of the judgment or at any other after the judgment is entered.
How to Transfer an IRA
Although the process of transferring an IRA looks simple on paper, it is still complex enough that if you were to miss one technicality, the transfer can still trigger income tax. This is why having a divorce attorney by your side is so important.
In any case, a transfer of an IRA can be done in one of two ways:
Transferring a fixed amount or percentage of one spouse’s IRA to the other spouse’s IRA.
Setting up a new IRA to which the will be transferred
Remember that if any retirement funds are cashed out or distributed and then paid to the spouse or ex-spouse, the IRS will see this as a taxable event to the original IRA’s owner. In other words, it is crucial that any transfer of IRA funds is conducted as an actual transfer—not a distribution.