How to Split IRAs and Other Retirement Plans During a Divorce

Divorcing? Know the right way to split retirement plans

If you are going through a divorce or legal separation, you will most likely be required to divide the assets you have in your retirement plans. In some cases, the assets may be awarded to one party. Whether you are giving up funds or receiving them, you need to understand the rules that govern asset division in a divorce.

The type of retirement plan—that is, whether it is an IRA or a qualified plan—determines the rules that apply. Mishandling how you define and allocate retirement-plan assets in a divorce can cost you plenty in taxes and aggravation.

Key Takeaways

  • During a divorce, you will not be expected to pay taxes on the immediate division of retirement accounts as long as you file them correctly with the courts.
  • QDROs—qualified domestic relations orders—manage the division of retirement accounts that are not IRAs.
  • IRA divisions are classified as transfer incidents.
  • Updating your beneficiaries during the divorce can be easy to overlook, but make sure you do it.

Dividing Qualified Plan Assets vs. IRAs

Even if you and your spouse will divide the assets in your IRAs and qualified plans in exactly the same way, a separate legal term applies to each type of division. IRAs are divided using a process known as "transfer incident to divorce," while 403(b) and qualified plans such as 401(k)s are split under a qualified domestic relations order (QDRO).

You and your spouse need to clearly delineate the category into which each of your retirement assets falls when you submit your information to the judge or mediator so they are listed correctly in the divorce or separation agreement. Not doing this can produce unnecessary complications.

Dividing a Qualified Plan: QDRO

Divorce constitutes one of the few exceptions to the protections from seizure or attachment by creditors or lawsuits that federal law accords to qualified retirement plans. Divorce and separation decrees allow the attachment of qualified-plan assets by the ex-spouse of the plan account owner if the spouse uses a Qualified Domestic Relations Order. A QDRO is used to divide qualified retirement plan assets between the owner and their current or ex-spouse or children or other dependents.

QDROs resemble transfer incidents to divorce in that they are tax-free transactions as long as they have been reported correctly to the courts and the IRA custodians. The receiving spouse may roll QDRO assets into their own qualified plan or into a traditional IRA or Roth IRA (in which case the transfer will be taxed as a conversion but not penalized). Any transfer from a qualified plan in a divorce settlement that is not deemed a QDRO by the IRS is subject to tax and penalty.

A QDRO must comply with the Employee Retirement Income Security Act (ERISA). ERISA provides a regulatory framework for employer-sponsored retirement plans to provide protections for beneficiaries and participants. IRAs are not subject to ERISA.

Dividing an IRA: Transfer Incident

If you specified that your IRA division is to be treated as a transfer incident to divorce in your agreement, no tax will be assessed on the separation transaction. The movement of funds may be classified as either a transfer or a rollover by the IRA custodian, depending on the circumstances of the division and how the decree is worded.

The recipient will take legal ownership of the assets when the transfer is complete and then assume sole total responsibility for the tax consequences of any future transactions or distributions. This means that if you are going to give half of your IRA to your soon-to-be ex-spouse in the form of a properly labeled transfer incident, they will have to pay the tax on any distributions they take out of the account after they receive the funds. You will not owe tax on the assets that were sent to them because you followed the IRS rules for transfer incidents.

If, however, you failed to adequately label your division as such, you will owe both tax and an early withdrawal penalty (if applicable) on the entire amount that your ex-spouse received. In order to avoid this, be sure to clearly list both the division percentage breakdown and the dollar amount of IRA assets transferred, as well as all the sending and receiving account numbers for all of the IRAs involved in the transfer.

The instructions that you provide need to satisfy both the sending and receiving IRA custodians, as well as the judge and state laws. If the division agreement is not approved by the courts, the IRS will require you to file an amended tax return that reports the entire amount you sent to your ex as ordinary income. In addition, the balance your ex-spouse received cannot be put into an IRA because it was not an eligible transfer. This means your former spouse will lose the benefit of tax deferral on that money—and may come back to you to be compensated for that loss.

It can be incredibly beneficial—and well worth the money—to hire a financial professional to assist in the splitting of retirement or any other type of financial account. For example, Certified Divorce Financial Analysts (CDFAs) specialize in the division of assets when spouses divorce.

Tracking the Basis of IRA Assets

Some qualified transfer incidents are made from an IRA that has been partially funded with nondeductible contributions. If this is the case with you, then both you and your ex will need to know the dollar amount of nondeductible contributions and file tax Form 8606 with the IRS in order to correctly calculate and report the allocation of the nondeductible amounts.

Beneficiary Designations

After you send or receive your IRA or qualified-plan assets, be sure to add or update your beneficiaries. Your ex-spouse will probably not be one of them unless your divorce decree requires it. (Also, be sure to update the beneficiaries on all your other financial assets, including annuities and life insurance.)

If you are going to get remarried and/or your children are now going to be your primary beneficiaries, it may be prudent to create a revocable living trust and make the trust the primary or secondary beneficiary of your plan or account. An estate-planning attorney can help you accomplish this and ensure that your retirement assets will be dispersed in the manner that you desire.

The Bottom Line

If the courts and the IRA and/or qualified-plan custodians recognize your divisions as QDROs or transfers incident to divorce, there will be no tax consequences for you or your ex. A lack of attention to detail in properly handling the division of retirement assets can make the divorce process that much more complicated and expensive, especially if large sums of money are involved.

Article Sources
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  1. Internal Revenue Service. "Publication 504 (2020), Divorced or Separated Individuals."

  2. Internal Revenue Service. "Retirement Topics -- QDRO -- Qualified Domestic Relations Order."

  3. Internal Revenue Service. "About Form 8606, Nondeductible IRAs."