If you own an IRA and are getting a divorce, there is a good chance it will need to be split in same fashion pursuant to your divorce settlement. This is becoming more common now that approximately one-quarter of divorces today happen among couples who are over age 501, also know as “grey divorce”.
By that time retirement savers have typically built up substantial balances via contributions or rollovers from career changes.
Divorce after 50 can be especially gut-wrenching since many people are just on the cusp of retirement. This often translates to a lifestyle shift where spending more time with children and grandchildren, or traveling become a top priority. Divorce can bring these aspirations to a screeching halt.
With so many of the nation’s divorces occurring during ages at which financial stability is increasingly important, the likelihood of retirement assets such as IRAs needing to be divvied up is particularly high.
Do I Need to Split My IRA With My Ex?
As you might have guessed, it depends. Here are some considerations:
- IRAs can be considered marital property if acquired during marriage.
- Whether or not your IRA is considered marital property also depends on your state’s specific laws:
- If you reside in a community property state, marital assets including IRAs typically need to be split equally.
- If you reside in what’s called an equitable distribution state, marital assets may be split unevenly based on a number of factors.
- If you acquired an IRA before marriage, some of the balance can still become marital property if at any time during your marriage you funded the IRA with joint funds. This is typically the case with other assets acquired before marriage as well.
How Do I Split An IRA When Getting a Divorce?
Whether you are the owner of an IRA or the party being awarded some of your ex-spouse’s IRA funds (alternate payee), you need to understand the options for splitting these accounts.
In a previous article we discussed using a “Qualified Domestic Relations Order” or QDRO to split most employer sponsored retirement plans. However, when splitting an IRA (Traditional IRA, Roth IRA, SEP IRA, SIMPLE IRA, etc.), A QDRO is not applicable!
The most common way to split any IRAs in a divorce is to spell it out in your “divorce decree” or “separation agreement” which is drafted by an attorney. You will likely want terms to split any IRAs using a percentage rather than flat dollar amount, but that is not always the case.
The reason to use a percentage is that the account can fluctuate up or down during the process of drafting and finalizing a decree. Therefore it is possible for one of the two parties to end up with an unfair amount. You will also want to make sure that the timing of the split is clearly defined, and what the responsibilities are for each party.
Once a decree or separation agreement has been finalized you still need to be aware of some important final steps:
- To transfer IRA proceeds to an alternate payee, the IRA owner must provide a copy of the decree or separation agreement to their current IRA “custodian” (the institution holding the money).
- Then, the custodian must have an IRA account opened in the alternate payee’s own name to send the funds to.
Planning Tip: As the alternate payee, you don’t necessarily have to open your IRA at the same custodian, but it makes the transfer process much cleaner. You can transfer your IRA out to a custodian of your choice later if you choose. Remember a “custodian” is the financial institution holding the account.
- A trustee-to-trustee or direct transfer should be used to transfer funds to the alternate payee’s IRA in order to avoid creating a taxable event. The original IRA owner (payor) should avoid making the mistake of withdrawing part or all of the IRA, and then paying it to the ex-spouse (payee). This would result in taxable income to the original IRA owner and potentially a 10% penalty if under age 59 1/2. Once given to the ex-spouse, those funds could also be considered taxable income to them as well!
Additional Items To Consider
We believe having something drafted by legal counsel is the cleanest way to go about this process, as opposed to trying to beat the system. Using some alternative method of transferring funds just to avoid paying any legal fees or costs could cause larger issues down the road.
Remember you only get once chance to split your IRA during your divorce and you will want legal documentation to prove that everything was done accurately. Merely agreeing with the other party on a set of terms and divvying up an IRA yourselves probably won’t work and you wouldn’t have any legal documentation to back it up.
The recent Tax Court case; John R. Kirkpatrick v. Commissioner, TC Memo 2018-20, (February 22, 2018) serves as a prime example of why not to go it alone. You will also want to make sure your legal documents state who is responsible for opening any potential new accounts, when, and where they should be opened.
The costs of the drafting and filing process can be paid based on whatever the parties agree to (for example, split costs 50/50). Sometimes we see that one of the parties can’t seem to agree on sharing the cost.
If you are the receiving party and an agreement is difficult to reach, you may want to consider covering the entire cost if feasible. You will need to weigh the actual cost of the drafting and filing of a decree vs. what it may cost you to not do anything, and leave the account “as is”.
For example: If you are the receiving party and plan on cashing out and using some of the money soon (possibly subject to ordinary income and 10% penalty), the investments in the account could take a turn for the worse and you could end up with less.
The Bottom Line
- It can be tricky to properly split an IRA in divorce. Be careful not to make costly mistakes.
- Remember to review the beneficiaries on your IRA post divorce. This is especially important in families with beneficiaries from different marriages! You can change your beneficiaries at any time.
- If there are multiple retirement accounts or assets in the divorce, consider other strategies that may be available to you with the help of a financial planner and attorney.
- Even though the value of an IRA may appear similar to another asset in the divorce, retirement accounts such as IRAs are pre-tax. This means all of the money will be subject to taxation when withdrawn. Many other assets such as home equity are not taxed the same. Remember to account for the differences in taxation between different types of assets.
Cameron Valadez is a CERTIFIED FINANCIAL PLANNER™ located in Riverside and Orange County, CA.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, and CFP® in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
This is meant for educational purposes only. It should not be considered investment or legal advice, nor does it constitute a recommendation to take a particular course of action. Please consult with a financial professional regarding your personal situation prior to making any financial related decisions.
1 Brown, S.L., & Lin, I.-F., (2012). The gray divorce revolution: rising divorce among middle-aged and older adults, 1990–2010. Journals of Gerontology Series B: Psychological Sciences and Social Sciences, 67(6), 731–741, doi:10.1093/geronb/gbs089. Advance Access publication October 9, 2012.