IRA in Divorce — Do I Have to Pay A Penalty to Transfer It To My Spouse?
This is a common question people ask me. The answer is that you can transfer any pension assets between the two of you pursuant to a divorce without any tax penalties or income tax. However, you must do it correctly. You need to have your attorney prepare a Domestic Relations Order, which is submitted to the Court. The Court will sign it. You then submit it to the financial institution that is holding your IRA and they will transfer the funds to an account in your spouse’s name. If you just decide to cut a check you will end up with substantial tax penalties. Don’t do it that way.
IRA — How Do I Fund It?
You can only fund an IRA with cash or a cash equivalent. You can’t put your house or your jewelry into an IRA. You can transfer, roll-over, or convert another retirement asset into an IRA without any penalty. The maximum contribution for 2013 is $5,500 for anyone under 50 or $6,500 for anyone over 50. Any contribution has to be from your own income. The maximum contribution is not per account, in includes all traditional and Roth IRAs.
If you or your spouse is already covered by an employer-based retirement plan and have an income beyond a certain threshold the amount that you can contribute to an IRA and receive the tax benefits is reduced. Above a certain income you get no benefit at all. The thresholds vary depending on your filing status and other factors.
IRA — What Are Valid Investments?
You can invest your IRA assets in most kinds of securities (stocks, bonds, etc.). You can’t put your baseball card collection in your IRA. You can’t put your residence into your IRA, but you may be able to hold rental property in your IRA. The rules in this area are quite complicated; you need professional advice on this.
Your IRA can borrow money, but you cannot personally guarantee the loan and the loan can only be secured by assets in the IRA.
IRA — How Can I Take Money Out?
Typically you can withdraw money from an IRA without tax penalties after you are 59 1/2. You still have to pay income taxes on what you take out. Also, except for a Roth IRA, you have to take out a certain percentage of the amount in the IRA every year once you are 70 1/2. If you don’t take out the minimum you have to pay a penalty of 50% of the amount that you should have withdrawn. Quite a penalty! The minimum that you have to withdraw is based on IRS tables; ask your accountant. If you leave an IRA to someone when you die the same rules about minimum distributions apply, based on the life expectancy of your heir.
There are some limited exceptions that allow you to withdraw money before you are 59 1/2. They are known as hardship withdrawals. The rules are quite complicated.
The rules concerning Roth IRAs are somewhat different. Since you contributed to the Roth IRA with money that you already paid taxes on you can ordinarily withdraw the amounts that you contributed without penalty.
IRA — What About Bankruptcy?
Some IRAs, such as rollover from Simple IRAs or Roll-Over IRAs are exempt from the bankruptcy up to at least $1M without having to show that you need it for retirement. Other IRAs, such as employer-sponsored 401(k)s are entirely exempt.
IRA — Protection from Creditors
You can protect your IRA from creditors by rolling it over into a qualified plan, like a 401(k). You could take a distribution, pay the taxes on that, and then protect what is left along with other assets. You could use the state law exemptions for IRAs.
IRAs — Borrowing
You cannot borrow money from your IRA except for a two month period during any one calendar year. It is really just to satisfy a cash flow problem.
IRA — Inheritance
You can leave your IRA to your heirs; if you die while you are married your spouse can inherit it. If your spouse inherits your IRA he or she can (i) treat the IRA as if he or she had it to begin with, (ii) roll it over into his or her already existing IRA, (iii) turn it down, so that it goes to the children, or (iv) take it all out in one lump-sum, and perhaps to subject to income taxes.
If someone other than your spouse inherits he is she cannot treat the IRA as if he or she had it to begin with, but can take the other choices outline above.
IRA — Get Professional Advice
As you can see from the summary in this article, the rules about IRAs are really complicated, If you don’t do it right you may have major tax liabilities. IRAs are great way to save for retirement, but make sure you get professional advice on how to handle them.
IRAs- Can I Deal With Them in Divorce Mediation?
IRAs and other pensions assets come up in most mediated divorces. We deal with these issues routinely. Mediation is a cost effective way to deal with the transfer of pension assets in divorce. Give us a call to set up a free consultation.