Getting divorced can raise some important financial questions, including how to handle the division of retirement assets. If you and your soon-to-be former spouse have individual retirement accounts you might be wondering how to split an IRA in divorce equitably or whether you even need to. The division of those assets can depend on whether the accounts are considered marital or separate property and how property is divided in your state. Consider speaking with a financial advisor to help navigate you through this potentially complicated situation.
What Is an IRA?
An IRA, or individual retirement account, is a tax-advantaged account that allows you to save money independently of an employer-sponsored retirement plan. There are two basic types of IRA: Traditional and Roth.
Traditional IRAs allow for tax-deductible contributions and tax-deferred growth. Qualified withdrawals are taxed at your ordinary-income tax rate and early withdrawals may be subject to a 10% penalty. Beginning at 72, you’re obligated to take required minimum distributions (RMDs) from a traditional IRA and you can no longer make new contributions.
Roth IRAs don’t offer a tax deduction for contributions but qualified withdrawals are tax-free. Original contributions can be withdrawn at any time and there are no required minimum distributions associated with these accounts. As of 2022, the annual contribution limit for both traditional and Roth IRAs is $6,000 or $7,000 if you’re age 50 or older.
Who Gets an IRA in Divorce?
There are legal rules that apply to assets in general and retirement accounts in particular when making divisions in divorce. Where you live is going to play a huge role in how assets are split by law. In order to determine how to split an IRA in divorce, you first have to consider two things:
- Whether IRAs are considered to be marital or separate property
- How marital property is divided under your state laws
Marital property generally means any property a couple acquires while they’re married. So that can mean real estate, vehicles and retirement accounts. An IRA that was opened after the marriage took place can still be considered marital property even if it’s owned by one spouse and the other spouse is not listed as the primary beneficiary.
Separate property is the property that was owned before the marriage. If you opened and contributed to an IRA before you were married, for example, that IRA would be separate property. But that distinction can get tricky since some states may deem contributions made while you were married as marital property. And still, other states may allow contributions that were made after separation but prior to divorce to be categorized as separate property.
IRAs inherited by one spouse are usually considered to be separate property. These accounts can fall under the marital property umbrella, however, if they’re commingled with assets belonging to the other spouse.
In terms of how marital property is divided at the state level, a handful of states follow community property rules. That means that legally, spouses are considered to jointly own all assets acquired during the course of the marriage. In those states, courts may use a 50-50 spit to divide IRAs and other assets as part of the final decree.
If you live in an equitable distribution state, on the other hand, the court can divide IRAs and other assets based on what’s considered fair to both spouses. That doesn’t mean you and your spouse can’t work together to form your own agreement about how to split an IRA in divorce. But it’s up to the court to decide whether to approve such an agreement.
How To Split an IRA in Divorce
Splitting an IRA in a divorce proceeding starts with understanding how much of the money in the account is marital property. For that, you’ll need to know:
- When the IRA was opened
- How much was contributed to the IRA
- When those contributions were made
Again, an IRA becomes marital property once you’re actually married. So if you have an IRA going into the marriage, you should be able to exclude any amounts in the account up to that point. Marital property is the value of the account from the time you’re married up to either the date you legally separate or the marriage ends, whichever rule applies in your state.
So if you had $200,000 in your IRA before you got married and its value increases to $600,000 during the course of the marriage, only $400,000 of that could be considered marital property. Again, how much of that your spouse is entitled to depend on whether you live in a community property or equitable distribution state.
Once you’ve calculated the division of IRA funds, the next step is arranging for the transfer of the money. The spouse who’s on the receiving end will need to have their own IRA established. In your divorce decree, you can specify where the money is to be sent. Your IRA custodian can then handle the transfer of money to your spouse’s IRA.
At that point, they can do what they like with the money whether that means rolling it into a new IRA or withdrawing it. And the same goes for you if you’re the one who’s receiving a transfer of IRA money from your spouse.
Tax Implications For Splitting IRAs in Divorce
Assuming that IRA funds are transferred directly, meaning the custodian handles the movement of money, then there are no immediate tax consequences to either party. If either one of you decides to take a distribution from your IRA and you’re under age 59 ½, you’d owe income tax on the withdrawal and a 10% penalty.
A direct transfer of IRA funds is not required. The receiving spouse could request that a check be sent to them directly. They’d then have 60 dates from the date of the distribution to redeposit the money into an IRA. There are, however, some things that make this a less attractive option.
For one thing, the original IRA custodian will withhold 20% off the account balance for taxes right off the bat. That means if you’re receiving money from an IRA as part of a divorce settlement, you’re automatically getting 20% less than you would with a direct transfer.
The other issue is what happens if you fail to put the money back into an IRA within the 60-day window. If you don’t deposit the money on time, then the entire amount is treated as a taxable distribution. Again, you’ll owe income tax and a 10% early withdrawal penalty if you’re under age 59 ½.
Do You Have To Split an IRA in Divorce?
You don’t necessarily have to hand over part of your IRA to your spouse if they’re willing to reach a compromise with you. You might offer them assets that are equivalent in value to what they’d get if you were to split your IRA. Instead of giving them $400,000 in IRA money, for instance, you might allow them to keep your vacation home that’s valued at $400,000.
Whether it makes sense to make—or accept—such an offer can depend on your overall financial situation and goals. Talking to your financial advisor can help you decide if this option is worth considering. You may also want to talk to your tax professional about any potential tax implications that might be involved with settling other assets on a former spouse.
Remember that anything you decide with regard to property division needs to be put in writing and approved by the court. Making verbal agreements about financial or other issues relating to the divorce could only cause issues down the road for you and your ex-spouse.
The Bottom Line
Determining how to split an IRA in divorce starts with understanding the property division laws in your state. A good divorce attorney or even an estate planning attorney should be able to explain how it works where you live. And if you expect to receive IRA assets following a divorce, be sure to give some thought to the best way to put them to use.
Retirement Planning Tips
- If you’re unsure, you can talk to your financial advisor about the best way to approach splitting an IRA in divorce and alternatives you might want to consider. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you or your spouse has a 401k or similar retirement plan at work, you’ll need a qualified domestic relations order (QDRO) to divide those assets. A QDRO is required for each account you’re splitting and your plan sponsors are responsible for distributing funds to the recipient spouse. Fortunately, you do not need a QDRO to divide IRA assets.
Photo credit: ©iStock.com/Slphotography, ©iStock.com/Andril Zastrozhnov, ©iStock.com/PeopleImages