Dividing Retirement Accounts in Divorce


by Robert D. Bordett~ Retirement accounts are one of the largest assets to be divided amongst a couple in the middle of a divorce.  There are 2 types of retirement plans: Qualified plans and Non-Qualified plans.  Your 401K, Profit Sharing, 403b, and pension plans are Qualified plans.  Non-Qualified plans are IRA, SEP IRA, and Roth IRA.

What do you need to divide up a Qualified plan?

In order to divide up a Qualified plan, you need a QDRO (Qualified Domestic Relations Order).  This is an order prepared and then presented to the court.  It allows the participant employee to transfer an amount from their account to a non-participant’s account (the other spouse’s).  The person receiving it may have it transferred to an existing or new retirement account.  There are no tax consequences for this transfer. Taxes are paid only when money is withdrawn from the account.

The recipient has the choice to have some or all of the transfer sent to them directly instead of into a retirement account.  If this is done, they will pay federal and state taxes.
There is usually a 10% penalty if one is under 59 ½, however, if you are undergoing divorce proceedings, you may be able to avoid this. The IRS code [Internal Revenue Code Section 72(t)(2)(C)] allows the exception of the 10% penalty at the time of the divorce.

For example, if a wife let all of a $100,000 distribution go into her IRA and then withdrew $50,000, she would have to pay federal and state taxes plus a 10% penalty.  If the husband transferred half of his $100,000 from his 401K into his soon to be ex-wife’s IRA and half directly to her, she’d have to pay an additional $5,000 in taxes.

At the time of transfer, the IRS will have 20% deducted as a prepayment of tax, if the recipient chooses to have any portion sent to them, instead of putting it into the retirement account.
To illustrate this point, let’s say the husband is going to transfer $100,000 from his 401K to his soon-to-be-ex-wife.  The wife decides that she wants $50,000 to go into her IRA and $50,000 sent to her directly.  $50,000 will then be sent to her IRA and then $40,000 will be sent to her ($50,000 less the 20% federal tax withheld, which equals $10,000).

What do you need to divide up a Non-Qualified account?

The soon to be ex-spouse can roll over money tax-deferred from their IRA into an IRA set-up for the their soon-to-be-ex if, and only if, the transfer is called for by the divorce property settlement.  It is always recommended that they have a letter of instruction at the time of the transfer.

If you transfer money to your ex without having the proper language in the divorce decree, you will be responsible for any applicable taxes, plus you will generally owe the 10% penalty if you are not 59 ½ yet.

You cannot avoid the 10% early withdrawal penalty as you would with transferring a qualified plan.  The Internal Revenue Code Section 72(t)(2)(C) only works with qualified plans.
While all of this may appear relatively straightforward, it evidently is not.  Rarely does a month go by without a well-publicized court decision involving tax controversies from divorce-related IRA payouts.

How do people most commonly get into trouble?  Some try to transfer money before the divorce, thinking this is a tax-free transaction.  Nope.  As explained, any transfer will be treated as a taxable distribution to the IRA owner (the person in whose name the account is set up). Others try to satisfy post-divorce financial obligations to their ex by making IRA withdrawals. Once again, this will always trigger an immediate tax bill for the IRA owner, even though the ex gets the money.

What about Social Security?

“My husband and I are getting divorced. He is 63 and I am 62.  We’ve been married for 20 years. I hear that I will be eligible to collect 50% of his social security. His income was higher than mine.”
This question comes up frequently. The short answer is “yes”.  If you are divorced after at least 10 years of marriage you can collect benefits on your former spouse’s social security if you are at least 62 years of age and your former spouse is eligible to collect or is currently collecting Social Security.  In this scenario you would get 50% of your ex-spouse’s benefit or 100% of yours, whichever is greater.  There is an exception to the rule if you remarry.
The Social Security Administration website (ssa.gov) is a great resource for questions related to divorce and social security.

A lot of information and I don’t recommend that you try to figure this out at the kitchen table. Look to get advice from a divorce professional.

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About Robert Bordett

Bob is founder of Collaborative Practice & Mediation Services, Inc. a firm providing financial analysis in divorce, and business mediation and a founding partner in Divorce Innovations. Bob is a Certified Financial Planner, Certified Divorce Financial Analyst, and Registered Mediator and Arbitrator with the Georgia Office of Dispute Resolution. Bob is a Founding Member of Academy of Professional Family Mediators, Past President of Family Mediation Association of Georgia, Past Board Member of Georgia Council For Dispute Resolution, National Association of Tax Practitioners; Past President of the Collaborative Law Institute of Georgia and a founding member of the Atlanta Collaborative Divorce Alliance.

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