While no one marries with the intention to later separate, if divorce or legal separation is in your future, make sure you understand the implications against retirement savings. If you or your spouse have money in retirement plans, you’ll most likely have to share the assets. It’s important to understand what governs the division of these assets to ensure the right party is responsible for paying applicable taxes. The type of retirement plan – IRA or qualified plan – determines the rules.
A separate legal term applies to each type of division. IRAs use a process known as transfer incident to divorce, while 403(b) and qualified plans, such as a 401(k), are split under the Qualified Domestic Relations Order (QDRO). You need to clearly define into which category each of the retirement assets fall when you submit your information to the court, so they’re listed correctly in the divorce or separation agreement.
A transfer incident to divorce isn’t taxed. The movement of funds can be classified as either a transfer or a rollover by the IRA custodian, depending on the circumstances of the division and the wording in the decree. The recipient takes legal ownership of the assets after the transfer is complete and assumes sole total responsibility for taxes on any future transactions or distributions.
A QDRO is used to divide qualified retirement plan assets between the owner and their current or ex-spouse or children or other dependents. Like transfers incident to divorce, QDROs are tax-free transactions so long as they are reported properly to the courts and the IRA custodians. QDRO assets can be rolled into a qualified plan, or a traditional or Roth IRA. Before a divorce settlement, any transfer from a qualified plan not considered a QDRO by the IRS is subject to tax and penalty.
Dividing retirement assets in a divorce can be less difficult if the correct information is provided to all parties involved. If the courts and custodians of the IRA and/or qualified plan recognize your divisions as QDROs or transfers incident to divorce, there shouldn’t be tax consequences. Lack of attention to detail can make this stressful time even more complicated and expensive, especially if large sums of money are involved.
Call our office, we are available to help you and your legal counsel provide the information needed to divide your retirement plan assets.
Johnson Financial Advisors does not provide tax advice; coordinate with your tax advisor regarding your specific situation.