Retirement Plans and Your Social Security

IRA's-Be Careful--It's Not As Simple As It Looks

Although some that will argue otherwise, it is prudent to make a transfer IRA money from one party to the other with a Retirement Benefits Order. Otherwise, the account owner will pay income taxes on the amount withdrawn and will also pay 10% early withdrawal penalty if he/she is under age 59 and 1/2.  Also, 20% will be withheld for taxes.  An IRA transfer may appear to be simple, but it still requires some care.

 

                                                                    

Tax-Free Distribution

When one spouse transfers an individual retirement account (IRA) or a portion of an IRA to a spouse or former spouse under a divorce decree or under a written instrument incident to a divorce, that transfer is not considered a distribution to the owner of the IRA. The Internal Revenue Service (IRS) has also ruled that entering into a post-nuptial agreement that provides for the distribution of an IRA in the event of a divorce is not treated as a distribution. Transferee Becomes Owner In any of these cases, the transferred IRA is considered to belong to the recipient spouse and not to the original owner. This means that the recipient is not required to take distributions from the IRA after he/she receives it even if the original owner spouse was taking distributions as part of a series of substantially equal periodic payments.

Transfer After Divorce

A transfer of an IRA to an ex-spouse can only be made after the divorce is final. If the account owner transfers part or all of an IRA before the divorce is final, he/she could be taxed on the distribution and possibly incur a 10-percent early-distribution penalty.  After the divorce, the account owner should transfer an IRA in a timely manner. If a divorce decree does not require the division of an IRA, then a transfer to the ex-spouse will be considered a taxable distribution to the account owner if transferred more than one year after the date of divorce. If you're learning curve needs a boost, see Tax Free IRA Tranfers--Must Be "Incident to a Divorce". If nothing else, shows why good advice is needed before you dive too deeply into these waters.

Rollover—Not Direct

An IRA transfer should be done via direct transfer (trustee-to-trustee) from one IRA account to the other. If you take a distribution from your IRA in the form of a check and give it to your ex-spouse, he /she will be taxed on that distribution. 

Method of Transfer

Whether an IRA is transferred in its entirety to the non-account-holder or divided between the two parties, there are two methods of transferring the non-account-holder's portion:

•Keep the name on the original account or

•Change the name on the original account.

Keep Name on Original Account

If all or a portion of your account is being transferred to your Ex-Wife, the most common method of transfer is for her to set up a new, temporary IRA account at your custodian company to receive the transfer. Once the transfer of her portion is made, she should transfer the funds from the temporary custodian account to a new IRA account with the custodian of her choice. If she wants to keep the IRA with the first custodian, then, of course, there would be no need to establish a second IRA account with a different custodian. When part or all of an IRA is transferred, the transferee is treated as the original account owner for his portion. For example, he keeps the original tax basis of his portion as his own basis. It is important for him to have copies of the applicable records of the original account.

Change Name on Original Account

A second method to use when all or a portion of the account is being transferred to your Ex-Wife is to simply changed the name on the account to that of your Wife. If only a portion of the IRA is being transferred, you can transfer your portion to a new IRA account, leaving your Ex-Wife's share in the original account. The name on the original account can then be changed to that of the your Wife. This method tends to give the original account-owner more control over the transfer. When part or all of an IRA is transferred, the transferee is treated as the original account owner for his portion. For example, he keeps the original tax basis of his portion as his own basis. It is important for him to have copies of the applicable records of the original account.

Trade-Offs?

If you are making an IRA transfer as part of a "swap" of one property for another,  it is important to look at the after-tax effects. Two assets may appear to be of equal value, but they may be significantly unequal when income taxes are taken into account. Unfortunately, calculating the tax effect on an IRA is not as straightforward as it may appear. The exercise requires several assumptions as well as a crystal ball. The younger the IRA account owner, the more precarious the tax-effect calculation. A few issues to be considered in the calculation include type of IRAs, anticipated tax rates, tax law changes, income sources, income level, deductions and filing status. In the example of the residence traded for the IRA, the home sale may occur in the short run while IRA distributions may be expected to occur decades later.

Check Your Beneficiaries

Whether or not there have been any transfers of IRA funds, after the divorce, you should be sure to update beneficiary designations with your IRA custodians. Of course, probably need to update your entire estate plan. Outdated beneficiary designations can result in unintended heirs and some very unwanted surprises!

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