Many couples make the mistake of assuming that IRA balance transfers in a divorce are easy – just because they don’t require a Qualified Domestic Relations Order or QDRO. It is true that IRA transfers can be done smoothly and without tax consequences to either spouse, but that outcome requires advance planning and careful execution.
Here is what you need to know.
IRA transfers in a divorce are referred to as a “transfer incident to divorce” to distinguish them from the transfer of qualified plan accounts such as 401(k) and 403(b) that are governed by a QDRO. There are a few possible scenarios for an IRA transfer, but the most common ones include a transfer of a portion of the IRA balance to an ex-spouse. Regardless of how much of the account balance is being transitioned between ex-spouses, there are a few key things to remember.
IRA Transfer, Done Right!
Double-Check the Paperwork
The IRA transfer must be formalized in a divorce decree. Make sure the document includes specific details, for example the name of the institutions, account numbers, amount to be transferred and the date of the intended transfer. If including a specific transfer date is not practical, the transfer date can be worded as “on date of divorce” or some other appropriate language. Check with your attorney for the complete information and the specific language needed.
Wait Until the Divorce is Final
Remember that an IRA transfer falls under the category of “transfers incident to divorce”. That means that your divorce must be final before any IRA balances are transferred. Speak with your attorney to understand the timeline, as the “divorce final” date is not the same as the date you and your ex-spouse sign the divorce decree. Failing to get the timing right can cost the transferor spouse a 10% penalty plus income tax on the amount transferred.
Execute the Transfer Timely
On the flip side of transferring the IRA too soon, there is such a thing as waiting too long. Generally, the IRA transfers incident to divorce must be completed on a reasonable timeline (typically within one year). If the divorce date and the IRA transfer date are spaced too far apart, it may lead to the transfer being classified a distribution with all the related tax consequences and possible penalty. If the transfer will be made significantly subsequent to the date of divorce, speak with a tax CPA for important details.
Direct Transfer is Key
IRA funds must be transferred via a direct trustee-to-trustee transfer, not through a check between ex-spouses (no matter how easy and tempting that path might look). A check will be deemed a distribution with tax consequences. If you want to maximize the speed of the transfer, consider having the recipient establish a temporary account at the custodial institution which holds the original IRA account. Once the balance is in the recipient’s temporary IRA account, the recipient can transfer his or her IRA to another custodian. Of course, that will mean doing another direct transfer.
Keep in mind that if 100% of the account value is being transferred to a new owner, it is possible to simply change the name on the account and skip the need for any transfers.
Understand Ownership Change
Upon transfer, the IRA is deemed to belong to the recipient, not the original owner. That means that the new owner does not have to continue to take the distributions that the original owner may have been taking. This is good news, as the recipient spouse is not locked into any decisions that his or her ex-spouse previously made regarding regular distributions.
Closing Thoughts on IRA Transfer in a Divorce
As you work with your financial planner and attorney to structure the amounts and the timing of the transfer, remember to look at tax consequences of ownership transition. In some cases, taxes may be triggered, which means that the ultimate outcome of the settlement will look different than intended.
Finally, be sure to verify owner and beneficiary names on all accounts. Missing this important step can lead to an unexpected inheritance for an unintended heir!