Dividing Assets in a Divorce Without Adding to Your Tax Burden – (Retirement Accounts)
Dividing assets in a divorce is complicated, especially when retirement accounts come into play. Beyond this, rules vary based on the type of property your former spouse receives. Luckily, there are ways around increasing your tax burden. Learn about post-divorce retirement plan transfers here…
Employer Retirement Plans
If one of the spouses takes a retirement distribution and writes a check for the amount to their former spouse, the plan participant will owe income taxes on the distribution (and 10% additional tax if it is an early distribution), not the former spouse.
What Tax Form Should The Plan Participant Expect?
The plan participant will get a tax form 1099-R and should report it on their individual federal tax return.
Enter the Qualified Domestic Relations Order (QDRO)
But what if you want to transfer tax responsibility to your former spouse?
To transfer the tax responsibility to the recipient spouse, the plan participant can use a qualified domestic relations order (QDRO), which is a court order that gives retirement plan rights to a former spouse. After a QDRO is granted, the recipient spouse will get a 1099-R and report the distribution on their own tax return.
Note: The 10% additional tax on early distributions never applies when a distribution is made pursuant to a QDRO.
Rollovers to a Former Spouse’s IRA
Recipient spouses can rollover their QDRO distributions to their own IRA
The rollover of the QDRO distribution to an IRA must be accomplished within 60 days of obtaining the distribution to avoid negative tax consequences. However, the recipient spouse should keep in mind that while the QDRO isn’t subject to the 10% additional tax, any subsequent distribution from the IRA before age 59½ is potentially subject to it.
Transferring Individual Retirement Arrangement (IRA) Assets
If an IRA owner takes a distribution and simply writes a check to their former spouse in a divorce, the IRA owner will receive Form 1099-R and report the taxable income and any additional tax on their federal income tax return, not the recipient spouse.
Unlike employer plans, QDROs don’t apply to IRAs.
How Can IRAs be Divided Without Tax Consequences?
An IRA can be divided between former spouses by transferring assets from the IRA owner’s account to the IRA of the ex-spouse. The transfer should be provided for in the post-divorce decree or legal separation. When this occurs, the transfer is tax-free. The recipient spouse is subject to tax on subsequent distributions.
We can help
Dividing assets in a divorce is tricky… And unexpected tax pains are common during a divorce proceeding. So, if you’re considering a divorce or in the process of divorcing should think carefully about how splitting up retirement savings will impact their taxes and their retirement income stream. Not sure how divorce could impact returns? Connect with a tax advisor to help you.