Untying the Knot


The song “Breaking Up Is Hard to Do” hit Number One on the Billboard Hot 100 on August 11, 1962. 57 years later, the lyric still rings true.

In traditional Judaism, marriage is viewed as a contractual bond commanded by G-d in which a man and a woman come together to create a relationship in which G-d is directly involved. (Deut. 24:1) However, when a couple divorces, not only will they need to sort through many emotions and dissolve that spiritual contractual bond along with all legal entanglements, but they must also dissolve joint accounts and separate potentially many years’ worth of accumulated property.

When a couple divorces in Texas, the court will divide their community property as it deems “just and right.” When you divorce, the court (or you and your spouse, if you can agree) will divide your property. Texas is a community property state, which means that most property acquired during marriage belongs to both spouses and must be divided at divorce. In contrast, each spouse gets to keep his or her separate property when the marriage ends.

Among the property which needs to be divided when two spouses go their separate ways is likely to include retirement accounts. If you are going through a divorce, your retirement savings may have taken a serious hit. Because most people can no longer rely on traditional pensions as their sole source of retirement income, most individuals contribute to a diversity of retirement funds. Understanding how divorce impacts the various types of financial accounts will help you both rebuild after the dust settles.

Splitting up on the brink of retirement can be catastrophic for your finances. Even if both partners have worked there tend to be uneven levels of wealth among them. Women in particular may have taken time off work for family reasons and that eats into lifetime earnings.

When you’re a woman who’s 50+ and divorcing, there’s no question that retirement accounts, pension plans and social security will factor significantly into your divorce settlement agreement — but even if you’re not nearing retirement age, the same is likely true. For many couples, retirement accounts and/or pension plans represent a considerable chunk of their net worth, and as such, they all must be addressed in divorce settlement agreements. Unfortunately, though, dividing retirement accounts and pension plans is:

  • very complicated,
  • fraught with many tax implications and
  • often mishandled (since many lawyers don’t have sufficient expertise in this area).

If you’re divorcing, here are a few of the key elements you need to keep top of mind:

Court-Ordered Divorce Decree Is a Must
Some of my clients make the mistake of thinking that entering into a casual agreement as a divorcing couple to settle the division of their property without the involvement of a court will save them emotional distress, time, and money. This is often not what they ultimately experience. The mere fact that a property settlement is agreed upon and signed by the parties will not, in and of itself, constitute a legal divorce decree. It is possible, however, for divorcing parties to agree to terms as to how property, including IRAs, should be divided and then submit the agreement to the court for approval. With the court’s approval an informal agreement can become a court order that would allow the moving of the IRA funds.

Preparing for a Retirement Account Transfer Due to Divorce
The divorce decree should be specific about how and when assets are split. If the IRA is invested in assets that fluctuate in value, the date that the IRAs divided may be critical. The divorce decree also should clearly state who is responsible for any fees and how they are paid. Don’t assume that your divorce attorney is well-versed in how IRAs should be handled in a divorce. This is a very specialized area. If a divorce decree is unclear on any of these matters, a licensed financial advisor ought to be consulted and he or she may consider asking the court for more clarification. In rare circumstances, a divorce decree may need to be revised.

How to Transfer IRA Funds in a Divorce
Procedures followed in cooperation with the IRA custodian are essential to fulfilling the court order.

To get the ball rolling, the advisor or IRA owner should provide a copy of the divorce decree to the IRA custodian. Without this, the IRA custodian has no authority to move the IRA funds, so the custodian will want to see this document before proceeding with any transactions. The IRA owner should then complete paperwork with the IRA custodian, authorizing a transfer of the IRA (or the portion of it) awarded to the former spouse. Because the account belongs to the IRA owner, the authorization must come from him or her to move the funds. Also, the IRA owner is the one subject to the court order. The former spouse may already have her/his own IRA. If so, the funds may be transferred to that retirement account. If the former spouse does not have an IRA, then they will need to establish one in order to receive the IRA funds awarded under the divorce decree.

The correct way to divide IRA funds in compliance with the divorce decree is to perform a trustee-to-trustee transfer of the funds, moving them from one spouse’s IRA to the other spouse’s IRA. However, before this transaction is set in motion, each spouse’s financial advisor will want to review the divorce decree carefully. A divorce decree mandating a division of an IRA is a court order requiring the IRA owner to act, not the IRA custodian.

There is no reporting issue to the IRS. Forms 1099 – R and 5498 are not required because the transaction is handled as a trustee and not as a distribution and subsequent rollover. There are no tax consequences to the IRA owner or the former-spouse for the transfer of the IRA.

After the Transfer Due to Divorce
After the transfer due to divorce, if the funds remain in an IRA, there would continue to be no tax consequences. However, if the spouse who receives the funds decides to take a distribution from the IRA, that distribution would be taxable. If the spouse who takes the distribution is under age 59 ½, then a 10% early distribution penalty will apply. Although the funds are transferred due to divorce and may even have been distributed to pay costs associated with the divorce, there is no exception to the 10% penalty available here. A spouse awarded IRA funds due to divorce may convert those funds to a Roth IRA.

Beneficiary Designations
Neglecting to update the beneficiary designation forms and leaving an ex-spouse listed as a beneficiary is unfortunately a common mistake that can have costly consequences. That might be the last thing you want and could be very difficult, if not impossible, to fix if not discovered until it is too late.

What if you really do want to leave your IRA to your ex? You should still update your beneficiary form. Why? Well, some states are starting to adopt legislation that revokes a beneficiary designation naming an ex-spouse upon divorce.

Required Minimum Distributions
Older divorcing couples may be concerned about the impact of the IRA transfer due to divorce on the required minimum distributions (RMDs). If an IRA owner is taking RMD’s, there is no provision for adjusting the balance used for the calculations in the year the IRA is divided due to divorce. The client will still need to take an RMD calculated using the December 31 prior year balance. This may result in a much bigger RMD than anticipated on a much smaller IRA. The good news is that this will only happen once. The December 31 balance in the year of the division will be smaller after the split of the Ira assets and used to calculate the RMD for the next year.

For younger couples who may have been taking substantial equal periodic payments to avoid the 10% early distribution penalty, there may be questions about whether the payment schedule may be adjusted to reflect the smaller balance that results from a transfer due to divorce. There is some good news here: Private letter rulings have allowed this without it being considered a modification of the payment plan.

Social Security Benefits
If your marriage lasted 10 years or more, you may be entitled to receive Social Security benefits from your former spouse’s account. Federal law allows you to collect benefits if you are unmarried, age 62 or older, if your ex-husband or ex-wife is entitled to benefits, and his or her benefits exceed the amount you would receive on your own. Drawing upon your former spouse’s account does not diminish the amount of Social Security he or she receives.

Divorce is hard enough for all the emotional, spiritual, social, and other turmoil involved. Don’t let disentangling your financial union be another source of pain or anxiety.

My mother always said “Four eyes are better than two” so, if you would like a fresh pair of eyes to help guide you and your attorney please feel free to contact me. Let’s make sure your financial future is clear. While breaking up is hard to do, divorce should offer you a sense of freedom, personal renewal, and hope.

Mark S. Gardner spent 23 years at Bear Stearns, overseeing the local Wealth Management department. Gardner has managed over $175 million for high net worth individuals and families in Dallas and at his boutique, family-run firm, RetireWellDallas, the mission is helping people retire happy! Offering the same blue-chip services of Wall Street giants, but with personalized attention and a focus on retirement income strategies, RetireWellDallas helps clients design tax advantage strategies and retirement income plans that optimize their Social Security benefits and investments, as well as plan long-term care, college funding for children and grandchildren, and much more. For a complimentary assessment of your financial plan, contact Mark via email at MarkGardner@RetireWellDallas.com or call (214) 762-2327.