How can I divide my retirement without taking a tax hit?

If you simply take a withdrawal from your retirement account to provide your former spouse with a portion of it, incident to divorce, it will create a tax event. There are ways to divide the account, however, without experiencing a tax penalty.

If you are dividing an IRA you’ll need to make sure that the transaction is structured so that you are not taking a distribution. In order to do so, you’ll need to have the transaction reflect that it is a ‘transfer’ or ‘rollover.’ By structuring the transaction the transferring party will avoid a tax penalty.

The receiving party will need to deposit the funds into an IRA or other eligible retirement account. Transferring the funds into a non-IRA account will create a taxable event.

If you are dividing a qualified employer plans such as 401(k)s, pensions, and SEP IRAs, the best way to ensure that transferring all or a portion of the funds to a former spouse doesn’t result in tax penalties is to obtain a Qualified Domestic Relations Order (QDRO). This is just a legal instrument that allows for a person to assign rights in a retirement account to another person. This order will allow the account to be separated and withdrawn with no tax penalty, so long as the funds are deposited in another retirement account. The order itself will be sent to the plan administrator after it is signed by a judge, and it will instruct the administrator as to how the funds are to be dispersed.

Non-qualified plans, plans that aren’t required to adhere to ERISA, are usually reserved for high-ranking and highly paid employees. Most of these plans cannot be touched by a QDRO, and can almost never be divided or assigned to a spouse. For these plans, the spouse entitled to a portion of the plan should receive the value she is entitled to in other ways, or enter into an agreement which prescribes a transfer to take place once the employee-spouse actually receives payment from the plan (usually at retirement).

 


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