Divorce isn’t easy, especially when it comes to splitting up the assets you’ve built as a couple. One aspect that often gets overlooked at this stage is how retirement plans should be divided, but you need to give this some attention as well.
Your nest egg is as important as your home and other assets, if not more so. After all, this is the only way you can plan your financial security in your golden years, when you no longer have a regular income to pay for your needs. If you have children or other dependents, proper retirement planning becomes even more crucial!
Dividing IRA and Qualified Plan Assets during a Divorce
Different rules apply to qualified retirement plans and IRA savings, even if you and your spouse intend to divide them the same way. To ensure that your retirement assets are listed accurately in the divorce or separation agreement, ensure they are clearly categorized while submitting your information to the judge or mediator.
Based on the kind of retirement plan in question, you need to list it under a Transfer Incident to Divorce or a Qualified Domestic Relations Order in your divorce or separation agreement. Here’s the difference between the two:
Transfer Incident to Divorce – While dividing your IRA assets with your ex-spouse, you need to label this transaction as a Transfer Incident to Divorce in your agreement, to avoid taxes on this transaction. Ensure that the dollar amount of assets being transferred from the IRA and the division percentage breakdown are clearly listed, along with both sending and receiving IRA account numbers.
The IRA custodian may classify the transaction as either a rollover or a transfer based on the wording of the decree and circumstances of the division. After the transfer is complete, the tax responsibility for these assets will no longer be upon you. However, you may be liable for taxes or early withdrawal penalties on the amount of funds that your ex-spouse receives if the division is not labelled correctly.
Qualified Domestic Relations Order (QRDO) – Any qualified retirement plans such as a 401k or 403b will need to be reported under this category, so they can be divided between you and your ex-spouse, as well as any dependents or children. Qualified plans are usually protected from seizure or attachment by lawsuits or creditors, but a QRDO allows plan assets to be attached by the owner’s ex-spouse through divorce and separation decrees.
Your ex-spouse may rollover these assets into their own qualified retirement plans or an IRA, but they may need to pay taxes for conversion if they opt for the latter. Like a Transfer Incident to Divorce, a QRDO is not subject to income tax or penalties as long as the transaction has been reported correctly. If the transaction is not classified as a QRDO, however, you may be liable to pay both income tax and early withdrawal penalties.
Do You Need to Consult an Attorney or Financial Specialist?
With the right attention to detail and thorough research, you can certainly handle this division yourself. However, there are many aspects of taxation and reporting that need to be tackled while splitting up retirement plans, so it’s often safest to consult a financial advisor or tax attorney for assistance.
If the division of shared marital assets isn’t handled properly, it could lead to serious issues down the line for both you and your ex-spouse. In addition, incorrectly reporting the division of assets in retirement plans can also lead to extra taxes, penalties and delays during your divorce proceedings.
Whether you have a self-directed IRA or employer-sponsored qualified plan, it’s important to ensure that they are split up fairly and applicable taxes are also taken care of the right way. Getting the correct advice will make this process a whole lot easier!