Differences in Distributions due to Divorce
By Lisa Haberman, MBA, MAM, ChFC, CLU
Divorce is a difficult topic for many people to discuss, but the actual process of a divorce can be even more daunting for couples who have shared assets in a variety of investments, including assets earmarked for retirement. How do divorced couples navigate the process of dividing retirement assets held in individual retirement arrangements (IRAs) and employer sponsored retirement plans? Here are a few questions that help sort out the differences in distributions due to divorce.
Can an ex-spouse roll over IRA assets awarded by a divorce decree into his own IRA?
Yes, individuals who are awarded all or a portion of their former spouse’s IRA through a marital settlement or divorce decree may generally transfer or roll over the awarded assets into their own IRA. Financial organizations should not complete the rollover transaction until they receive a copy of the divorce decree (or other written instrument, such as a court-approved property disposition). If a distribution is given directly to the ex-spouse or legally separated spouse pursuant to a divorce decree or separation agreement, the financial organization should generate a corresponding Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., in the recipient’s name. The distribution would then be eligible for rollover, provided all the rollover rules were met. Financial organizations that choose to allow rollovers in such situations—particularly a financial organization that was not a party to the distribution event and is not familiar with the court documentation— may wish to obtain a written, signed statement or a hold harmless agreement acknowledging that the financial organization informed the individual of his options and that the client will not blame the organization if the IRS disallows the transaction. A rollover would not be available to an ex-spouse who had only a verbal agreement to give all or a portion of her IRA to a former spouse: a written divorce decree or other legal document would need to authorize the transaction.
Can an ex-spouse roll over retirement plan assets to her own 401(k) or other eligible retirement plan?
Yes, an ex-spouse (i.e., an alternate payee) may roll over assets from the former spouse’s employer plan, through the instrument known as a qualified domestic relations order (QDRO). First, the plan administrator must receive a domestic relations order (DRO) created by the applicable court. The plan administrator will then determine if the terms set out in the DRO meet the criteria needed to be a QDRO; and if they do, will authorize the rollover to the alternate payee’s employer retirement plan or IRA. The timing of the rollover will depend on the terms of the former spouse’s retirement plan. The plan may provide for a distributable event for the alternate payee in divorce or legal separation circumstances; but if this option is not permitted by the plan, the alternate payee will not be allowed to distribute and roll over the assets until the former spouse attains a distributable event under the plan (including age 59½, normal retirement age, disability, death, etc.).
Will a 10 percent early distribution penalty tax apply to the rollover amount?
This penalty tax does not apply to distributions paid to alternate payees from most non-IRA employer sponsored retirement plans. It does, however, apply to IRA distributions. If the alternate payee rolls over retirement assets to her own IRA, the 10 percent early distribution penalty tax will apply to any pre-59½ distribution taken from the IRA after the rollover has been completed.
Are there other steps that financial organizations should take?
The key to navigating a distribution or transfer of retirement assets awarded to a spouse in divorce proceedings is to first understand the type of account (IRA or employer plan) in which the retirement assets are held. Once this is determined, the appropriate documents may be drafted and forwarded to the account owner’s custodian or plan administrator for processing and reporting. Reviewing these steps may help both spouses move forward with less uncertainty.
