When a Marriage Ends, What Happens to Your IRA?
Though no one likes to admit it, divorce is a very real possibility for many marriage in the U.S. – with between 45 % estimated to fail*. It is undoubtedly a stressful occurrence, but it’s important to not let yourself be taken advantage of. There are a number of financial traps the unsuspecting can fall into, especially when it comes to your IRA or 401(k) accounts.
Depending on the type of retirement plan, the rules could differ on how they can be divided in a legal separation. Retirement accounts are often the largest single asset a person has in a divorce, other than their home, so it’s important to be equipped with the right information.
It's also important to underscore the information provided here is only meant as general information and not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Transferring an IRA
According to Section 408(d)(6) of the Internal Revenue Code, the transfer of an individual’s interest in an IRA to a former spouse is not a taxable transfer. The spouse who gives up the assets is no longer responsible for any future taxes or penalties from distributions that may occur. The receiving spouse, however, will be responsible for any taxes or penalties once it becomes their IRA.
Keep in mind though, if funds are distributed then paid to the ex-spouse, it is considered a taxable event for the original owner of the IRA. For a tax deferred movement of funds, the IRA must be ‘transferred’ NOT ‘distributed’.
To make the process easier, it’s likely a good idea to have the court order detail exactly how the IRA should be transferred.
Splitting IRAs vs. Qualified Plans
The rules for splitting up assets in a qualified plan, such as a 401(k). To transfer qualified assets, a qualified domestic relations order (QDRO) is required. An IRA, on the other hand, is split via the divorce agreement.
Once the court has issued the QDRO to the spouse requesting it, it then must be sent to the plan’s administrator to review. When the order is accepted, the receiving spouse will have whatever options the QDRO lays out – typically the choice between rolling the qualified plan assets into an IRA tax-free, or taking the distribution, which would still be subject to taxes.
An important difference to note: with a QDRO, distributions from a qualified plan are exempt from the 10% early distribution penalty. That means an ex-spouse younger than 59 ½ would be able to receive penalty-free distributions. But with IRAs, the penalty exemption is NOT waived. The government also states that an IRA cannot be transferred from the account owner to a new owner during the life of the original account owner.
The one and only way an IRA can be given from one owner to another during the original owner’s lifetime is through a court-ordered divorce decree or legal separation agreement.
Points to Remember
When splitting or giving away your IRA in a divorce, the transfer must be included in the divorce agreement. Upon finalization of the divorce, the divorce agreement should be sent to the IRA custodian so that the transfer process can begin. Once transferred, the recipient ex-spouse will take sole responsibility of all taxes and penalties. But keep in mind, if done wrong, the transferring spouse will have to pay taxes and an early withdrawal penalty, if applicable, on the entire amount that the ex is to receive.
Splitting up your IRA assets is tricky – especially so when you’re contending with the many other factors of divorce. We highly recommend speaking with your financial advisor and accountant on the best way to go about transferring your assets.
LPL Financial and Walsh & Associates do not provide tax or legal advice.