Couples will often split up an IRA as part of a divorce agreement. While getting divorced can be challenging or downright unpleasant, additional financial mistakes can make the process even more painful. A Michigan couple recently found this out when it lost a case against the IRS where the husband transferred $140,000 from an IRA to a checking account and failed to pay income taxes on the money.
According to a recent article in financialplanning.com, the arrangement following the divorce decree, but it was not handled in a financially prudent manner. The husband transferred money from an IRA to pay some of the obligations from the divorce, which stipulated that $100,000 would be paid from the IRA account to the wife and 40,000 would pay for the wife's legal fees.
What IRA owners can't do
Those dividing an IRA cannot transfer funds to a checking account. If this mistake is made, it often ends up leading to the fund owner to pay taxes. The husband transferred the funds from the IRA to his personal checking account and then made payments to ex-spouse and some of her creditors. The IRS successfully argued in court that these were withdrawals and not tax-free transfers.
What IRA owners can do
There are two ways to legally transfer funds without incurring taxes:
Trustee to trustee transfer: The first step is to create an IRA account for the recipient spouse if one does not exist. Then spouses can transfer funds from one IRA to another. This is defined as a transfer instead of a distribution that is subject to income tax.
Renaming the account: The original IRA account can be retitled in the spouse's name.
The right advice is crucial
It may be part of the original divorce agreement to divide the IRA. However, not all divorce lawyers are conversant on such financial issues as retirement accounts. It is advisable to provide the divorce decree to the custodian of the IRA before there is any transfer of funds. At the IRA owner's request, the custodian can then transfer the money using one of the above listed approaches. Sometimes the custodian can ask for additional clarification from the courts or have the arrangement amended in court to avoid these unnecessary taxes.
An attorney knowledgeable in family law and divorce, particularly high-asset divorce, will often be aware of how to resolve financial issues during and even after a divorce. Thus they can be a genuine resource to couples going through divorce.