Tuesday, May 7, 2013

How to Distribute Funds in an Individual Retirement Account (IRA) In a Divorce Without Tax Penalties

The term "Qualified Domestic Relations Order" (frequently abbreviated "QDRO") refers to a specific type of legal form that used for the purpose of dividing a retirement account or plan in connection with a judgment of divorce. QDRO's are used for the division of pensions, 401K accounts, and any other type of retirement asset that is subject to the federal law known as ERISA.

Because individual retirement accounts (IRA's) are not subject to ERISA, IRA's are generally easier to divide than pensions and other types of retirement assets. The legal forms that are used to dividing individual retirement accounts are commonly referred to as QDRO's even though, technically speaking, the written instruments needed to effectuate the division of an IRA are less technically demanding than what is normally encountered in drafting QDRO's.

When an interest in an IRA is to be transferred from one spouse to another in conjunction with divorce, the Internal Revenue Service has straightforward procedure, with the requirement that there must be a "written instrument" directing the transfer before the transfer actually occurs. Generally, the transferred interest in the IRA is viewed as the recipient-spouse's property and, therefore, this conveyance is tax-free. Sample forms (frequently referred to as QDRO forms) that may be used to satisfy the IRS's "written instrument" requirement are available for download online.

The most common method is the direct transfer. The IRA owner-spouse may order the IRA trustee to transfer the necessary IRA assets directly to the trustee of a new or existing IRA in the name of the recipient-spouse. Another option is to transfer the assets the owner-spouse is entitled to keep to another IRA, leave the necessary amount in the old IRA for the recipient-spouse and change the name on the old IRA to that of the recipient.

A transfer is not considered "incident to divorce" unless it occurs after the final judgment/decree of divorce has been entered by the court. After entry of the divorce judgment, the account owner should transfer an IRA in a timely manner.

Should an individual give IRA assets to a former spouse without receiving a court-approved divorce decree or separation agreement authorizing the change in ownership, the individual will be required to include the amount in his/her income, thus treating the transaction as a distribution to him/herself.

To protect the interests of both spouses, and clearly communicate the parties' intentions to the financial institution/IRA custodian, it is recommended that the parties prepare a domestic relations order setting forth the precise manner in which the IRA will be distributed. As noted above, a template QDRO for dividing an IRA may be found online.

In order to avoid confusion and minimize the risk of adverse tax consequences, it is advisable that parties enter into an agreement, similar to a QDRO (although, technically, not a QDRO) that specifically identifies the IRA and the manner in which it will be divided after entry of a judgment of divorce. QDRO samples, including sample forms for distributing IRA funds in divorce, may be useful for divorce litigants and attorneys alike.

Article Source: http://EzineArticles.com/4537619

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