You worked hard your entire life, got married, raised a family, maybe changed career paths a few times, and bam! You're getting divorced. Typically this is never a good thing, especially financially. Approximately one-quarter of divorces today happen among couples who are over age 50.1 This can be gut-wrenching since many people age 50 and over start thinking about things like retirement, spending more time with their children and grandchildren, or maybe traveling the world. Divorce could bring those aspirations to a screeching halt. The later a separation occurs in life the harder it can be. 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.
How Do I Split An IRA?
Whether you are the owner of an IRA or are the party to receive some of your ex-spouse's IRA funds (alternate payee), you need to understand the options for splitting these accounts. In a previous post we discussed using a "Qualified Domestic Relations Order" (QDRO) to split most employer 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 use some form of a divorce decree or separation agreement which can be 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 either party can possibly end up with an unfair amount. You will also want to make sure that the timing of the split/transfer 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 the IRA custodian (the institution holding the money). Then, the custodian must have an IRA account opened in the alternate payee's own name. A trustee-to-trustee transfer would then be used to transfer any funds to the alternate payee's IRA to avoid creating a taxable event. As the IRA owner do not make the mistake of liquidating part or all of the account to pay to your ex-spouse! This will result in taxable income to you and potentially a 10% penalty if you are under age 59 1/2. Once given to your ex-spouse, those funds would also be considered taxable income to them as well!
Things 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 do this and you will want legal documentation to prove that everything was done according to the requirements. 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. There was a recent Tax Court case; John R. Kirkpatrick v. Commissioner, TC Memo 2018-20, (February 22, 2018) which is 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, and 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 50/50). Although sometimes we see that one of the parties can't seem to agree on sharing the cost. If you are the receiving party (alternate payee), 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 alternate payee and plan on distributing and using some of the money soon (possibly subject to ordinary income and 10% penalty), the investments currently in the account could take a turn for the worse and you could end up with less.
The Bottom Line
Splitting IRAs in a divorce is tricky! Be careful not to make costly mistakes. The later in life the divorce the harder it can be to recover emotionally and financially. At that point, the feeling of "starting over" can in-and-of itself hinder one's ability to get back on track. This is especially true when the decision comes unexpectedly. You will need a support system by your side; friends, family, co-workers, and trusted professionals. When you need a professional in your support system to help you navigate new waters, we will be here to guide you.
Cameron Valadez is a CFP® Practitioner located in Riverside, 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 legal, tax or investment advice, nor does it constitute a recommendation to take a particular course of action. Please consult with your professional advisors 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.