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Dividing IRAs in a divorce: From your options to tax consequences

If your marriage is heading toward divorce, it's critical to make a list of your assets and debts. Retirement accounts are often among the most valuable assets, thus making them a sticking point in your divorce.

Knowing how to divide IRAs in a divorce can help you make informed decisions that protect your financial interests now and in the future.

What happens to an IRA?

In the event that you give up the IRA to the other individual, you're not responsible for any penalty of future distributions or tax. Instead, you can wash your hands of the asset and let the other party deal with it however they best see fit.

Conversely, if you're the one who receives the assets, you are responsible for any taxes and penalties associated with future distributions.

According to the Internal Revenue Code Section71(a)(2), a decree of divorce is required to make a tax free transfer of IRA assets.

Can you transfer an IRA?

It may be possible that you need to transfer an IRA, as opposed to surrendering the assets to your spouse. There are two ways of doing so:

  • Transfer a percentage of the balance or fixed amount from your IRA to that of your ex-spouse
  • Set up a new IRA to accept the transfer

The most important thing to remember here is that you don't want to cash out and then distribute the funds, as this results in a taxable event to the original owner of the IRA. The movement of funds should be a transfer, not a distribution.

One or both individuals can pay any fees or expenses associated with the transfer of funds.

Since there is more than one way to divide IRAs in a divorce, it's critical to understand your options and the tax consequences associated with each strategy.

Don't make the mistake of giving up all of your retirement assets in exchange for others. This may sound like a good idea now, especially if you're many years away from retirement, but you'll regret it at some point in the future.

Understanding your legal rights, options and tax consequences can help you make informed decisions that protect your finances now and in retirement.

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