When people divorce, their assets are usually split, including their retirement accounts. If mistakes are made during this process and taxes and penalties are involved, things get even more complicated. So let’s see how retirement assets are affected…
To properly divide an IRA because of a divorce, language specifying “who receives what” should be included in the marital settlement agreement (MSA) or the divorce agreement. A copy of this executed agreement should be given to your IRA custodian. The money should NOT simply be withdrawn from the IRA and handed to your ex-spouse. This would be treated as a taxable distribution to the IRA owner. Instead, the funds should be transferred to the receiving spouse’s IRA.
On the other hand, Employer Sponsored Retirement Plans or Qualified plans, cannot be split by a divorce agreement. Those plans require a special court order, known as a Qualified Domestic Relations Order, but everyone refers to it as a QDRO (pronounced qwa-dro). Once a QDRO has been issued, it should be sent to your employer plan administrator. The terms of the plan decide when you get the money. In some plans, a lump-sum is available immediately, while in others, the benefits may not be payable until the ex-spouse retires.
So what happens when you finally get control of the money? Good question, if you are receiving funds from an IRA, you should move the funds over to your own IRA to avoid taxes and possibly the 10% early distribution penalty. However, If you’re getting money pursuant to a QDRO (this means money from an employer plan), then you should strongly consider if you will need the money before you are age 59 ½. Why’s that you ask? Because money received directly from a plan - under a QDRO - are EXEMPT - from the 10% penalty. Not so in an IRA. If instead you roll that money over to an IRA and later you make a withdrawal before you are age 59 ½, you will pay the 10% early penalty, unless it is a qualified exception.
Ok, this next one brings all kinds of horror stories with it. One of the most common mistakes after a divorce is the failure to properly update beneficiary forms. We hear of nightmare after nightmare of people that did not have the right beneficiaries on their accounts. This is NOT something that should be overlooked. There have been many documented cases where a failure to simply update a beneficiary form led to an ex-husband or ex-wife receiving funds that was intended for your children or your new spouse. DON’T let this happen to you. Please make a note to update your beneficiary forms ASAP.
And always remember, you don’t have to do this on your own, contact us for professional help!
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.