If you’re considering a DIY divorce, complicated issues like dividing retirement assets are something to consider. Depending on your financial situation, dividing complex financial assets can be challenging without proper legal representation. Hiring a divorce attorney to help you with property division can help you ensure you avoid penalties by “checking all the boxes” when listing your assets.
In some cases, the assets may be awarded to just one party, but in most cases, you will be required to share these assets. The type of retirement plan determines the rules that apply.
IRAs are divided using a process known as “transfer incident to divorce.” With the transfer incident, no tax will be assessed on the transaction of separating the account. The movement of funds will be classified as either a transfer or a rollover. Once the transfer is complete, the recipient takes full legal ownership, responsible for the tax consequences of any future transactions.
It’s important that you correctly classify your IRAs as “transfer incident to divorce” when submitting your information to the judge or mediator. If they are not listed correctly in the divorce, you will owe both tax on the transfer and an early withdrawal penalty, if applicable, on the entire amount your ex-spouse receives.
As Investopedia explains, “The instructions that you provide need to satisfy both the sending and receiving IRA custodians, as well as the judge and state laws. If the division agreement is not approved by the courts, the IRS will require you to file an amended tax return that reports the entire amount you sent to your ex as ordinary income. Furthermore, the balance your ex received cannot be placed in an IRA because it was not an eligible transfer; this means he or she will lose the benefit of tax deferral on that money – and may come back to you to be compensated for that loss.”
Feel free to contact us about any questions you might have around this often confusing topic.