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.

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.

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.

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

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

Dividing a Variable Annuity in a Divorce Settlement

When you buy an annuity, you enter into a contract with an insurance company for future payments. In a variable annuity, rather than having a set amount for future payments, the payments depend on the earnings made by annuity investments. Variable annuities are tax-deferred so that investment earnings are not taxed until the owner gets the money. Dividing a variable annuity in a divorce without unintended adverse tax consequences is tricky. A financial professional and divorce attorney can help ensure the asset is divided to reach the intended result.

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.

How to Dissolve an Inherited IRA

An IRA is a qualified retirement account that receives special tax treatment. If a person dies with money still in the account, the IRA passes on to the beneficiary of the account. As a beneficiary, you generally have to withdraw all of the money within no more than five years or take minimum distributions annually for the rest of your life. However, a spouse can elect to treat the IRA as his own. You always have the option to dissolve the IRA, that is, take a distribution of the entire account, as soon as you inherit it. When you do so, you need to know how to report it on your income taxes as well as what the tax implication might be.

Get Divorced Online

Related articles

Can the IRS Charge Interest & Penalties While You're in Bankruptcy?

Bankruptcy rules and regulations – particularly regarding taxes – can be highly dependent on the chapter you file. ...

What Is 1099 Inheritance?

When you inherit a retirement plan from a deceased spouse or relative, you may have to pay income tax on distributions ...

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 ...

How to Avoid IRA Early Withdrawal Penalties in a Divorce

Because IRAs are tax-deferred accounts until you retire and tap into them, it makes sense that if you take the money ...

Browse by category
Ready to Begin? GET STARTED