How can I divide an IRA without incurring any income tax penalty? I’m Lee Rosen.
This is a question that comes up quite a bit. Lots of us have IRAs as a mechanism for saving for retirement. It’s also a good mechanism for avoiding income tax as we’re saving; it allows us to save more than we might otherwise be able to save. But in a divorce this is an asset, just like any other asset, that needs to be divided. Some assets are easy and straight forward, for instance dividing personal property; you take this, the other spouse takes that; straight forward. Even houses are not that complicated. We can often value the house and split assets, or we can sell it and split the proceeds. But IRAs are trickier because they are designed to have tax penalties if there’s an early distribution.
I see people, all the time who look at their IRA as a way to get a relief of financial crunch that they experience during separation. They figure hey I’ll just use some of this IRA money to get by until we get things straightened out. Be very careful of that course of action because that will immediately trigger a tax penalty. You’ve got to be very cautious about pulling money out early and then as you negotiate property division and it’s time to divide the IRA, you’re going to shift some of it from one spouse to the other, you have to do it in careful compliance with the tax law, or moving that money will result in taxing and potentially penalties.
So how do you deal with moving this money from one spouse to the other without incurring additional income taxes? First of all, do not, do not take a withdrawal. If you go into a bank and pull money out of your IRA, that’s going to result in income taxes, plus in all likelihood, a penalty. So just don’t do that. When you are ready to transfer IRA assets from one spouse to the other, do it as a transfer from one trustee to another. What that means is you’re having your bank or your IRA trustee transfer the money directly to a different account for your spouse. It might be that they’re transferring it within the same institution, or it might be that their doing it from one institution to the other; either to a new IRA account or to an existing IRA account. But if that money is carefully moved by the trustees from one account to the other, there will be no income tax and no penalty.
This is all very doable, it’s achievable, it’s routine for banks and other financial institutions to transfer IRAs. You just want to be careful that you do it in accordance with the rules, so that you don’t bump up against the tax laws and cost yourself a tremendous amount in penalties and taxes.
