Retirement Plans: Breaking Up Is Hard to Do

If you are going through a divorce or legal separation and you or your spouse have money in retirement plans, you will most likely be required to share those assets.  In some cases, those assets will be awarded to one party.  Regardless as to whether you are giving up or receiving assets, it is important to understand the rules that govern asset division in divorce. 

IRAs are divided using a process known as “transfer incident to divorce,” while 403(b) and qualified plans, such as a 401(k), are split under the “Qualified Domestic Relations Order” (QDRO).  You and your spouse need to visibly allocate the category into which each of your retirement assets fall when you submit your information to the judge or mediator.

In specifying that your IRA division be treated as a transfer incident to divorce in your agreement, no tax will be assessed on the separation transaction.  The recipient will take legal ownership of the assets when the transfer is complete and then assume sole responsibility for the tax consequences of any future transactions or distributions.  However, if you fail to sufficiently label your division, you will both owe tax and an early withdrawal penalty. 

QDROs resemble transfers incident to divorce in that they are tax-free transactions as long as they have been reported correctly to the courts and the IRA custodians.   The receiving spouse may roll QDRO assets into his or her own qualified plan or into a traditional or Roth IRA.  Any transfer from a qualified plan pursuant to a divorce settlement that is not deemed a QDRO by the IRS is subject to tax and penalty. 

See Mark P. Cussen, Divorcing? The Right Way to Split Retirement Plans, Investopedia.