IRAs in divorce situations are often complex. And while most of us don’t want to consider divorce, it does happen. Your legal separation agreement or divorce decree provides details on splitting any IRAs, so here are some things you need to know.
The paperwork should clearly detail specifics of the IRA split. Generally, a percentage is the best way to go. With percentages, market changes between the time you sign paperwork and when the account is actually split are realized. (In some situations, this can be a year or more.) For example, if a gain is realized during this time period, someone ends up with a larger share. Likewise, if there’s a large loss, someone ends up with a much smaller share. Also, if there are costs associated with dividing the account, make sure the paperwork clearly states who is responsible for which costs.
IRA assets should be directly transferred to the ex-spouse. This can only be done after all the legal paperwork has been finalized. Any withdrawal of funds prior to the finalization of the paperwork results in a taxable distribution to the IRA owner and cash being received by the ex-spouse. Any withdrawals by the IRA owner or by the ex-spouse, once the funds are in their own IRA, will be taxable and subject to the 10% early distribution penalty, if applicable.
There’s an additional nuance when the IRA owner is over the age of 70 ½ and a required distribution from their IRA is due for the year of the divorce. The RMD is based on the prior year end market value. Here’s what happens when Sandy, who is 72, gets divorced from Jack.
Sandy’s IRA had a balance of $200,000 as of December 31st last year. Splitting the IRA, Jack gets 50%. Sandy has an RMD of $7,813 ($200,000 / 25.6 = $7,812.50). Her RMD amount doesn’t change. Even after transferring half of her account to Jack, her RMD remains $7,813.
Jack doesn’t have to include the $100,000 received from Sandy in his RMD calculation for the year because it wasn’t in his IRA on December 31st. Although half of Sandy’s IRA balance transfers to Jack, half of her RMD doesn’t.
Now let’s change the scenario a bit. Sandy is transferring her entire IRA to Jack as part of the divorce settlement. It is Sandy’s only IRA account. She transfers the entire account to Jack in June before taking her RMD.
What happens to Sandy’s RMD for the year? There is no guidance from IRS on this scenario. The conservative approach would be for Sandy to take the RMD before moving the account to Jack.
But, a provision states when an IRA owner’s account balance declines to less than the required minimum distribution, the owner can take the remaining balance without penalty. Should the account balance reach zero, there is no required distribution and no penalty. Can Sandy rely on this provision to escape the penalty for not taking her RMD? This is a riskier approach since there is no guidance telling us that IRS or the Tax Court would accept this argument.