Emotional stress is the most commonly known aspect of most of the divorces. But the division of financial assets is also a major challenge. And one of the biggest and the most valuable of these assets is retirement savings.
But there are many factors involved like the type of treatment employed for division of various retirement accounts, the relevant laws, methods etc. This guide will help you understand all these facets so you can handle the division of your retirement accounts without unnecessary issues and hassles.
Let’s take a look at how the various retirement accounts are treated when it comes to dividing them, and also some key factors such as beneficiaries, applicable taxes and laws –
The division of these accounts is generally considered as a transfer incident to divorce, and should be completed within one year of divorce finalization. Beyond this one-year limit, the IRS can review any of the related transfers. It is important to label the transfer as ‘incident to divorce’ or else both the partners will be penalized for early withdrawal. The instructions provided regarding these transfers should be approved by sender and the receiver, as well as the judge and the state courts. If there is any discrepancy in any of the approvals then the amount transferred to your ex will be considered as ordinary income, and hence will be taxable.
Qualified plans are divided using a Qualified Domestic Relations Order (QDRO) – a court order which states the nature of benefits each spouse will receive when the benefits are payable. If these transactions are reported correctly to the courts and the IRA custodians, then they become tax-free. The receiver can add them to his or her own IRAs or qualified plan.
After transferring of assets, it is essential to remember that alterations should be done to your beneficiary designations. Qualified plans offer less flexibility in context to nominated beneficiaries. IRAs don’t automatically grant beneficiary rights to the spouse as they are not governed by state laws. So, make sure that your IRA beneficiary nominations are updated.
The Federal, State and the Local governing bodies, all have different laws for treating the properties involved in a marriage. Some support equal distribution wherein they assess the financial condition of each spouse, earning capability and years of marriage to ensure a fair division. Certain community property states treat any assets accumulated during marriage as joint properties of both the spouses, no matter who the owner is. Also, if the couple has a prenuptial argument in place, there might be some exceptions. Thus, know about the relevant laws before or during a separation.
These differ for different retirement accounts. For instance, your contribute to traditional IRAs pre-tax, while in case of Roth IRA you contribute after paying the income tax. So the tax implications on the withdrawals also differ.
The retirement accounts are divided on the basis of the present value of their benefits. If the account is a defined benefit plan, it’s difficult to gauge the current value. Hence it is advisable to consult a professional to get accurate calculations. But, if the account is a defined contribution plan, the current value is generally the amount present in the account as of a certain date. Post the determination of the present value, the account can be divided according to these two methods –
The benefits are not divided until they are payable as per the plan and the date mentioned therein. The division is cited in a QDRO. Apart from the divorce decree, this is a separate order signed by the judge.
The value of a marital property is compared to the current value of the retirement benefit. The owner of the account maintains the rights to its benefits while the other spouse is given the marital asset of equal value. This method is only and only feasible if the value of the retirement account can be established.
Remember, sound knowledge about the division of retirement assets will help you prevent a lot of tax issues and consequences. So learn more about what type of rules and laws might apply in your case. You can also consult your divorce attorney or a professional financial counselor regarding this.
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