How to LOSE an IRA in Divorce
I had an interesting question from an advisor. His married clients don’t like each other anymore. They have considered their options; stay together, get a legal separation, or get a divorce. They have decided to do none of these things. They don’t like each other enough to stay together so that option is out. And they are both too cheap to pay for an attorney so the legal separation and divorce options are out. Their solution – they will just split up all their assets and go their separate ways. Interesting….
However, one of their assets is his IRA. They want to split it 50/50 in a non-taxable event. In their eyes, this is fair. Unfortunately, the tax code does not agree with them.
AN IRA CANNOT BE TRANSFERRED OR ASSIGNED DURING THE LIFETIME OF THE ACCOUNT OWNER.
You will usually find this on the first page or so of the IRA agreement for any IRA account you establish. That is because this is what the law says. There is an exception for IRAs that are split as part of a divorce – one where you go to court and have legal papers that say you are no longer married. The kind that costs you money.
Either the divorce decree or a separation agreement that is incorporated as part of the divorce will spell out who gets what part of the IRA. After the divorce is granted by the court, you give the separation agreement or divorce decree to the IRA custodian. Then, the IRA account can be split into shares for both parties, or transferred entirely to the ex-spouse, if that is what was agreed upon, in a tax-free transfer. The IRA owner is left with an IRA, although it is smaller than it was before, and the ex-spouse also has an IRA. This is the ONLY way to split an IRA in a divorce that is a non-taxable event.
While an IRA is split in accordance with the divorce decree or separation agreement, a qualified employer plan, such as a 401(k), needs a QDRO (qualified domestic relations order) to accomplish the same thing. This is a legal document (actually at this point it is a DRO), approved by the court, which is given to the plan administrator. Once the plan administrator certifies it as qualified (now it becomes a QDRO), then the ex-spouse will have access to the plan funds – maybe. The QDRO cannot force the plan to do anything that the plan rules do not allow. The ex-spouse might have to wait for the plan participant to retire before being able to take a distribution from the plan.
Any time you take a distribution from either a plan or an IRA without a QDRO or a divorce decree and give the funds to your ex-spouse, you have a taxable distribution and your ex-spouse does not have a retirement account, they just have money. And you have a tax bill. It’s just not fair.
- By Beverly DeVeny and Jared Trexler