Divorcing comes with many emotional challenges that can often feel overwhelming. During this vulnerable time, people going through a divorce must make many important decisions that will affect their financial situation for years to come. It is common that during a divorce, a couple’s retirement assets are the largest liquid assets to be divided. If you are not careful, you could make decisions that have an adverse tax impact, costing you thousands of dollars. In order to avoid this, you must first understand what type of retirement plan you have.
Roth and Traditional IRAs
When transferring funds from one spouse’s IRA to another, this may constitute a “distribution” and result in steep early withdrawal penalties. Rather than distributing the assets, the transfer should be treated as a transfer incident to divorce. Timing is critical. If you fail to make a transfer within one year of your divorce settlement, you will be subject to review by the IRS.
The court and the receiving IRA custodians must approve the transfer. If the transfer application is denied, the funds will be considered “ordinary income” subject to taxation.
Once you have transferred your IRA assets incident to divorce, then the receiving spouse will be responsible for management of the funds. If they choose to distribute the funds, incurring penalties, that is in their discretion. Distributions after transfer will not result in a penalty for the spouse who transferred the assets incident to divorce—only the receiving/distributing spouse will be penalized.
Qualified plans include 401(k)s, Defined Benefit plans, and other pension plans. Dividing Qualified Plans incident to divorce is an extremely complex process. In order to effect a division, parties must obtain a qualified domestic relations order (QDRO). The spouse who is transferring their interest is referred to as the “participant.” The recipient is called the “alternate payee.” QDROs are tax-free transactions, but like an IRA, must be approved by the court and IRA custodians. The receiving spouse can elect to funnel the assets into their own IRA or qualified plan.
Whether you are dividing an IRA, a Qualified Plan, or a mix of both, make sure that you change your beneficiary designations. Even if your will says that all of your assets are to go to your children, if your ex-spouse is named as the beneficiary on your retirement plan, they will receive the benefits when you pass.
Towson Divorce Lawyers at Huesman, Jones & Miles, LLC Counsel Individuals Facing Divorce in Maryland
If you are contemplating divorce, you need an experienced lawyer by your side to ensure that your financial interests are protected. In the upheaval of divorce, people may feel like their retirement assets are not a priority. Hiring a qualified lawyer can help ensure that your nest egg does not become swallowed up by early withdrawal penalties and tax errors. Call the knowledgeable Towson divorce lawyers at Huesman, Jones & Miles today at 443-589-0150 or contact us online. With offices in Hunt Valley, Towson, and Pikesville, Maryland we represent clients throughout Baltimore County, Harford County, Carroll County, and Howard County including the towns of Essex, Columbia, and Bel Air.