Individual Retirement Arrangements are a particular type of tax-sheltered investment used by many Americans to save for retirement. Like other retirement plans, IRAs can be split between spouses during a divorce, giving one spouse a share of the other spouse's retirement savings. In such cases, the IRA must be properly rolled over from one account to another to avoid taxes and penalties on an improper transfer.
Retirement Funds Are Assets
Like most retirement funds and plans, IRAs can be considered marital assets regardless of whose name is on the account. Thus, a husband's IRA is not protected from distribution simply because it is only in his name. Instead, state law determines how the IRA is treated during the divorce. Generally, states consider money in an IRA to be a marital asset if it was earned during the marriage and not received as a gift or inheritance. However, an IRA fully funded with gifts from one spouse's parents, for example, could be considered the separate property of that spouse and, therefore, not divisible in the divorce.
A divorce court considers the couple's situation, as well as the types of contributions to the IRA, when deciding how to split the IRA during the divorce; the exact considerations can vary among states. Once the court decides how to split the IRA, if at all, it must issue an order describing the split. This order authorizes the transfer of IRA funds from the spouse whose name is on the account to the other spouse. With other types of retirement plans, the order is called a qualified domestic relations order and must meet certain requirements, but IRAs can be transferred with a divorce decree that does not necessarily meet those requirements. The decree, however, must specify how the account should be split and, depending on the financial institution's rules, may need to list the IRA's account number.
Transferring IRA Funds
With a signed court order or divorce decree, a spouse's financial institution can release funds to the recipient spouse. If the recipient spouse gets the entire IRA, the financial institution can simply change the name on the account. If the recipient spouse already has an IRA, the financial institution can directly transfer funds from one spouse's IRA to the other spouse's IRA. Or, the recipient spouse can set up a new IRA to receive the funds. The exact transfer process can vary among financial institutions.
Taxes and Penalties
If a recipient spouse pulls money out of the other spouse's IRA with a court order, but does not directly transfer it to a new IRA, the withdrawal is a taxable event. Withdrawals are generally taxed at the recipient spouse's income tax rate plus a 10 percent penalty. However, transfers between IRAs are tax-free, meaning no taxes or penalties are due at the time of the transfer. Although taxes may be due later when money is withdrawn, waiting until retirement to start withdrawing money means the recipient spouse will not have to pay the 10 percent penalty upon withdrawal. If a recipient spouse receives a distribution from the other spouse's IRA that is not directly transferred to a new IRA, he has 60 days to roll that distribution into a new IRA to avoid the tax penalty, but 20 percent of the distribution is withheld for tax purposes.