Avoiding tax penalties when dividing a retirement account
After the real estate crisis, a person’s retirement account may be the most valuable asset that a couple has at the time that they divorce. Certain rules pertain to this account and whether it is subject to themarital property division. Generally, individuals can experience significant tax ramifications if they cash out a part of their retirement account in order to split the account so that the spouse gets his or her fair share.
Fortunately, a qualified domestic relations order can help alleviate these tax ramifications. This special order by the court requires the retirement account to be split up. It may be used as part of a divorce or for enforcement of a spousal or child support order. The order requires a retitling of assets, in totality or in part, to another individual’s name. Under general circumstances, this retitling would trigger tax ramifications, such as treating it as a distribution that was subject to full taxation.
If the order is drafted properly, the spouse to whom the order is paid can acquire the same rights as the original owner of the retirement plan. This includes being able to roll over all or part of a distribution in a tax-free manner for a distribution made in compliance with a qualified domestic relations order. However, this order itself does not change the character of the retirement plan, so if actual distributions were made from the plan, they would taxed in the same way as a typical distribution.
Individuals who want to ensure that they receive a fair amount of marital property may discuss their options with a family law attorney. A lawyer may recommend ways that a person can acquire a fair share of assets, such as requesting a qualified domestic relations order.
Source: Forbes, “Taxes From A To Z (2014): Q Is For QDRO“, Kelly Erb, March 31, 2014