Who Pays the Taxes When Early Annuity Distribution Is Part of a Divorce Settlement?

By Rob Jennings J.D.

The spouse who receives the early distribution of an annuity in a divorce settlement is responsible for paying the taxes and any penalties. There are, however, ways to transfer the asset that avoids tax penalties. Also, the divorcing couple can consider the tax implications when negotiating their divorce settlement.

The spouse who receives the early distribution of an annuity in a divorce settlement is responsible for paying the taxes and any penalties. There are, however, ways to transfer the asset that avoids tax penalties. Also, the divorcing couple can consider the tax implications when negotiating their divorce settlement.

Early Distribution

Annuities are insurance products that pay income. They are often used as part of retirement. The Internal Revenue Service imposes a tax on certain early distributions of annuity funds. Most distributions that you receive from retirement plans and annuity contracts before age 59 1/2 are taxed an additional 10 percent. You pay taxes on the part of the distribution that you must include in gross income. It does not apply to the part of a distribution that is tax free. For example, you would not be taxed additionally on amounts that represent a return of your investment principal or funds that were rolled over to another retirement plan.

Divorce is never easy, but we can help. Learn More

QDRO

A QDRO, which stands for "qualified domestic relations order," is a judgment that is issued under state law. In order to be a qualified domestic relations order, the order must contain certain information, such as the amount or percentage of the benefit to be paid and the number of payments. It also cannot change the amount or the benefits of the plan. The QDRO recognizes the existence of a former spouse's right to receive all or a portion of the benefits payable to a participant under a retirement plan. You may be able to roll over all or part of the distribution into a traditional IRA.

Transfers

If an interest in a traditional Individual Retirement Account is transferred from your spouse or former spouse to you by divorce, the interest in the IRA, starting from the date of the transfer, is treated as your IRA. The transfer is tax free. The two ways usually used to transfer IRA assets to a spouse or former spouse is to change the name on the IRA and to make a direct transfer of the IRA assets. However, if there is a tax, the tax rules that apply to the former spouse who participated in the plan will apply to the other spouse as though she were the actual participant under the QDRO.

Negotiating

As with many divorce terms, a divorcing couple can negotiate the terms of an annuity transfer or early distribution. Therefore, it does not have to be that just one spouse pays all of the tax. The tax may be taken into account regarding the overall settlement. However, the IRS is not held to any agreement that you and your spouse make.

Divorce is never easy, but we can help. Learn More
How to Split an IRA in a Divorce Proceeding

References

Related articles

IRA Beneficiary Rules

An individual retirement arrangement is a savings plan designated for retirement purposes. By designating it as retirement savings and giving up the freedom associated with typical savings accounts, individuals receive preferential tax treatment. The type of plan – whether traditional IRA or Roth IRA – will determine the timing of the tax preference. Traditional IRAs provide the account holder with a tax deduction in the year the contributions were made, while Roth IRAs do not provide an up-front deduction, but allow for tax-free distributions at retirement. Given the tax benefits, individuals may contribute to an IRA until they reach age 70 1/2.

How Are Profit-Sharing Plans Divided in a Divorce?

While the division of assets can be complex in a divorce, profit-sharing and pension plans belonging to one spouse, or to both, offer an additional legal tangle. A federal law known as the Employee Retirement Income Securities Act applies guidelines on how companies set up and administer these plans, while the Retirement Equity Act covers how a divorce settlement may handle them.

How to Divide Deferred Compensation Accounts in a Divorce

Dividing tax-sheltered assets, such as deferred compensation accounts, in a divorce requires care. Many couples realize that, to avoid costly mistakes, splitting these accounts is best accomplished with the help of lawyers and accountants. The exact process for dividing accounts in a deferred compensation plan may vary depending on the plan specifications and state law.

Get Divorced Online

Related articles

Tips Regarding a Husband's Retirement Benefits in a Divorce

Financial disputes take center stage in many divorces and a court may decide how a couple must divide their assets ...

Husband's 401(k) & a Indiana Divorce

Yours, mine or ours? Divorce can take a nauseating bite out of your retirement savings, whether you live in a community ...

After a Divorce Ruling, What Is a QDRO?

A qualified domestic relations order, also known as a QDRO, is a legal document that allows an individual to give ...

Divorce and Dispersion of IRA

IRAs don’t usually require a qualified domestic relations order, or QDRO, for division between spouses in a ...

Browse by category