When spouses agree to divide an IRA account, they need a Property Settlement Agreement or court order stipulating the amount to be transferred. IRAs are not subject to the anti-alienation requirement of ERISA. Thus, QDROs are not needed to divide IRAs, even if the IRA is a rollover IRA from a qualified retirement plan. IRA Funds transferred from one spouse to another under a court order as part of a settlement can be made without tax penalties because they are the recipient-spouse’s property. The transfer is tax-free.
The IRS also offers two basic transfer methods for divorcing couples.
One, and the most common method, is the “direct transfer.” The IRA owner-spouse orders the IRA trustee to transfer the required IRA assets directly to the trustee of a new or existing IRA in the name of the recipient-spouse. Two, is called the “renaming method,” which is the transfer of assets the owner-spouse is entitled to keep to another IRA, leaving the necessary amount in the old IRA for the recipient-spouse, and changing the name on the old IRA to that of the recipient. A final alternative under the renaming method comes in handy if all the assets in the owner-spouse’s IRA are to be transferred to the recipient-spouse. A simple method of transfer is to just change the name of the account on the records of the financial institution.
When transferring IRA assets in a brokerage account as part of divorce, it is a good idea to inquire about specific paperwork for the transfer as well as any specific language and protocols in the agreement to facilitate this transfer.
The IRA custodian classifies the movement as either a transfer or a rollover, depending on the circumstances of the division and how the decree is worded.
The recipient owns the assets when the transfer is complete and assumes sole and total responsibility for the tax consequences of any future transactions or distributions. This means that if a husband gives half of his IRA to a soon-to-be-ex-wife in the form of a properly labeled transfer incident to divorce, she pays the tax on any distributions she takes out of the account after she receives the funds. The husband owes nothing because he followed the IRS rules for transfer incidents.
An improper division means the owner will owe both tax and an early withdrawal penalty, if applicable, on the entire amount that the ex-spouse received. To avoid this, use both the division percentage breakdown and the dollar amount of IRA assets being transferred, as well as all the sending and receiving account numbers for all of the IRAs involved in the transfer.