Are there alternatives to splitting the IRA?
When you choose divorce mediation, you and your spouse have many more options when it comes to splitting up your assets. In fact, if both spouses are in agreement, you can do almost anything you want. One spouse can keep ownership of the IRA while the other keeps something of equal value, such as the family home. Or one spouse can give the other a payment from another source. With mediation, it’s up to the two of you and the mediator you’re working with to arrive at an equitable arrangement. In regards to IRA money, one thing you and your former spouse will want to take into consideration is avoiding a withdrawal penalty.
That being said, before you take any action, make sure you won’t be subjecting yourself to tax consequences. Sometimes, and depending on the situation, tax penalties can be avoided through an IRA transfer.
Transferring an IRA
Usually when couples divorce and divide their property, including most financial assets, that property is not subject to federal tax; it’s considered a gift from one spouse to the other. However, if an IRA owner withdraws funds from the IRA to give to anyone–including the recipient spouse–that money is taxable.
Luckily for couples going through divorce, there’s an exception. If one spouse transfers their interest in the IRA to the other pursuant to a divorce or a separation agreement, those IRA funds are not taxable to either individual. There are some crucial conditions that must be met according to federal law for the couple to avoid penalties.
One, this is a privilege enjoyed only between spouses. IRA funds cannot be transferred to anyone else (like children)–even as part of the divorce decree or separation agreement–or income taxes will be owed on that money.
Two, the IRA transfer remains tax-free only if you and your former spouse do eventually divorce or separate. To avoid income tax on the transfer, it must be specified in the divorce decree or property settlement. In such transfers, the IRA becomes property of the recipient spouse.
Three, to avoid the wrath of the internal revenue service–something you would be wise to do–ONLY transfers incident to divorce are not subject to taxes. The transfer incident cannot be a way to cover support or alimony… or you will owe taxes. Of course, you can work out an arrangement with your spouse in mediation to include the IRA funds in the divorce settlement in lieu of something else. Individuals in mediation can address IRA assets in any way they feel is fair. It makes sense to both the IRA owner and ex spouse to avoid taxes if possible, though, and transfers incident to divorce are one way to make sure you’re keeping as much of your funds as possible.
