Divorcing couples must grapple with multiple decisions and negotiations. Many of these decisions are highly emotional ones, such as the allocation of parental responsibilities, who will get the family home, who will get the family pet, and even how various sentimental personal items that the couple amassed during their time together will be divided. Moreover, so many of these decisions revolve around the “present” that it can be easy to overlook the “future” issues, such as the division of retirement funds and pensions. This is where having a skilled divorce attorney assisting you can be critical.
There are several factors to consider when trying to determine how these funds will be divided, including what type of tax implications each spouse’s share will have. Depending on the type of retirement account, there could also be early withdrawal penalties to contend with if the transaction is not done correctly. Knowing ahead of time the best way to handle each of these accounts can save a lot of headaches—and money.
Types of Plans
Different plans require different procedures. Individual retirement accounts (IRA) are savings accounts which offer tax advantages while enabling people to save for their retirement. These accounts are usually offered by financial institutions, such as banks and credit unions. Qualified plans, such as 401(k) or 403(b) plans, are employer-sponsored plans. Employees can contribute to these accounts and there are no taxes paid on the amount in the account until the employee actually makes a withdrawal.
Transfer Incident to Divorce
When a couple is dividing an IRA, this should be treated as a “transfer incident to divorce.” By processing the withdrawal this way, there will be no tax assessed on the transaction. Additionally, depending on how the final divorce decree is worded, the division could actually be treated as a rollover instead of a withdrawal. If the transfer is not labeled as transfer incident to divorce, both parties could be responsible for early withdrawal penalty fees.
This withdrawal should be completed within one year of the divorce decree since any division after one year could trigger an IRS review.
Qualified Domestic Relations Order (QDRO)
When couples are dividing qualified plans, they are required to file a qualified domestic relations order, referred to as a QDRO. The spouse whose employer offers the qualified plan is referred to as the participant. The other spouse is referred to as the alternate payee. The alternate payee has the option to take these funds and add them to either his or her own qualified plan or an IRA.
Just as with a transfer incident to divorce transaction, those involving QDRO need to be clearly defined or else the parties can again face hefty early withdrawal penalties and fines.
If you and your spouse are considering divorce, the division of assets is just one of several issues which will need to be addressed. Contact an experienced DuPage County divorce attorney to discuss your legal options. Call Roscich & Martel Law Firm, LLC at (630) 793-6337 to schedule a confidential consultation today or visit our website for more information.