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How to Handle Retirement Accounts in a Divorce

Transferring property and assets during a divorce is a normal part of the process of going separate ways. Most of the transfers are fairly straightforward, however, the distribution of retirement accounts requires special attention or you run the risk of having to pay penalties and taxes that would otherwise have been avoided or become the responsibility of your ex-spouse. Even if the division of the retirement assets is a part of the court order or divorce decree, there are still taxes and penalties to be paid if it is not handled correctly.

Avoiding Taxes on an IRA

There is a way to make the transfer of the individual retirement account tax free, but you have to follow the steps very carefully. First, the division or transfer of the assets must be spelled out in the divorce decree, it cannot be a decision that you and your ex-spouse make on your own or that you handle before the divorce proceedings. Once it is a legal division, the portion of the account that is being transferred to your spouse must be rolled over into his/her own IRA account, whether existing or new.

What Happens if the Funds are not Rolled Over?

If the IRA funds are not rolled into another IRA account, the person that holds the account could wind up having to pay the taxes on the amount withdrawn. In addition, the owner could be liable to pay a 10 percent penalty on the amount of money that was withdrawn/transferred. The only exception to the rule is if the distribution can be proven to be a part of the divorce settlement and the person receiving the funds reinvests the money into another IRA within 60 days.

401K or Employer Sponsored Retirement Funds

If you own a 401K, which are retirement funds created and funded through your employer, the laws are a bit different. For this type of distribution, you will need a Qualified Domestic Relations Order, or QDRO. This order designates your spouse (soon to be called ex-spouse) as beneficiary to a certain percentage of the funds. This means that not only is he/she responsible for transferring the funds into an IRA, but he/she is also responsible for any future taxes when the money does eventually get withdrawn.

Transferring without the QDRO

If you skip the step of obtaining the QDRO, you could be putting yourself in jeopardy for tax liability on money that you no longer own. When tax time comes you could end up paying taxes on the money that was withdrawn as well as a 10% penalty for withdrawing the money before retirement age (59 1/2). The QDRO is a very important component of your divorce decree and should spelled out in a detailed fashion the name and address of each person, the accounts that are to be handled, how they are to be handled, and how the money is to be distributed, whether in lump sum fashion or in payments.

The common denominator in any type of division of retirement accounts is that the process needs to be spelled out in a divorce decree. Even if you think it is a good idea to try to handle things on your own without a lawyer and the courts, the government will soon get involved, costing you more money than you would have saved by using a lawyer and doing it right. This is especially true if you are involved in a “messy” divorce where one spouse is trying to harm the other. Leave no stone unturned – wait until the divorce is final and all decrees have been created in order to ensure your financial safety.