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Individual Retirement Accounts (IRAs) and your Divorce: Taxes and General Information

If you are in the beginning stages of your divorce, you likely have numerous questions about how your case will proceed.

How much is it going to cost you in attorney's fees? Are you going to remain in your home or will you have to move? What about your children? How are you going to pay for college without the assistance of your spouse? What about just seeing your kids- how is that going to work now that you and your spouse no longer reside together?

These are among the more frequently asked questions proposed to me by clients of the Law Office of Bryan Fagan, PLLC. Each of them has merit because the bottom line is that you have likely never been through a divorce before, and as a result, you don't know much about the process into which you are entering.

These questions come at you during work hours, before bed, and can wake you up at night. These questions relate to both immediate matters and more far-reaching matters and into the future.

One future matter that clients are left scratching their heads on with some frequency has to do with how Individual Retirement Accounts (IRAs) are divided in the context of a divorce. If you have been working for the better part of your adult life and have budgeted well and allowed yourself to be in a position where you can save for retirement, an IRA is a great vehicle. Depending on the type of IRA you choose, traditional vs. Roth, there are advantages to each.

Types of IRAs

Briefly, let's discuss the two types of IRAs. A traditional IRA allows you to save up to $5,500 per year ($6,500 a year if you are aged fifty or older), and your contributions to the IRA are not taxed. The catch is that upon retirement, you will be taxed at your future tax rate for any amounts taken out of the IRA.

A Roth IRA has the same contribution limits per year as a traditional IRA, but your contributions are taxed in the year they are made. The benefit to a Roth IRA is that when you take your money out at retirement, there will be no taxes applied as you have already paid taxes on the money as it went in. So, if you anticipate that your tax rate is higher now than it will be at retirement, or you are a younger person whose IRA will almost entirely grow in those contributions, a Roth is probably the best bet for you.

With that said, please do not mistake this blog for retirement or investment advice of any sort. The Law Office of Bryan Fagan, PLLC, comprises family law attorneys, not financial planners. Please seek the advice of persons who are knowledgeable in personal finance to find out what type of IRA works best for you.

IRAs in divorce

If you and your spouse get a divorce, then any IRA for you or your spouse can be divided up by a court order (Final Decree of Divorce) or by an agreement between you and your spouse made in mediation. However, there are issues to consider from a taxes perspective and possible delays that can come about of having to transfer funds in an IRA in a divorce settlement or judgment.

You can transfer funds in an IRA without incurring taxes if the following two conditions are satisfied:

  1. The transfer of IRA funds is ordered in your Final Decree of Divorce (either as a result of a judgment or mediated settlement agreement)
  2. There is a direct transfer of funds from one IRA to another IRA. This can mean that you both have an IRA, and only one of you has to divide the contents of your IRA and transfer the funds directly to the other's account. If you choose to take a check instead of a direct rollover, you cannot deposit the check into a new account. Doing so will still trigger a taxable event.

Taxes and Penalties if a successful rollover of funds is not completed

If IRA funds are transferred without adhering to the above principle can mean that you or your spouse (whichever of you is to receive the money) will owe taxes on that new amount (based on your tax rate) as well as a ten percent penalty on whatever the sum of money that was transferred out of the IRA.

For many of us, that looks like a 35% decrease in the amount of money you stood to receive from your spouse. Assuming that you and your attorney worked long and hard to negotiate that amount in your divorce, losing 35% right off the bat is, of course, not ideal.

In your divorce, if you receive a distribution from your ex-spouse's IRA in your Divorce Decree, then you will have up to 60 days to reinvest that money or to roll it over to your own IRA, as we had discussed in the previous paragraph. Even in this situation, you would only avoid the 10% penalty. 20% of that distribution will be withheld for tax purposes.

How to save time and money when it comes to an IRA and your divorce

Contact the financial institution that the IRA is with before your divorce has begun to see how to transfer IRA funds and whether or not you even need a copy of your Final Decree of Divorce to do so.

Suppose you anticipate receiving a portion of your spouse's IRA in your divorce. In that case, you can save some time and open up an IRA with whatever financial institution houses your spouse's IRA. Even if you are wrong and you are not awarded a distribution from your spouse's IRA, you would still be able to start to contribute after your divorce.

Finally, when it comes to drafting your Final Decree of Divorce, please make sure that the language referencing the account is specific inside. The last thing you want is for there to be an error in drafting or have the language be so vague as to be unenforceable or cause the financial institution to have problems transferring your spouse's IRA funds into your own IRA.

Questions about retirement accounts and divorce? Contact the Law Office of Bryan Fagan, PLLC

If you have retirement accounts and would like to know how they will be affected by your divorce, please get in touch with the Law Officeof Bryan Fagan, PLLC, today. A licensed family law attorney is available six days a week to meet with you and answer questions in a free-of-charge consultation.

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