When it comes to a legal separation or divorce, you would have to share the assets in your retirement plan. In certain cases, one party would be awarded the assets. To understand the laws that govern the division of retirement funds and 401(k) plans in a divorce, it is pertinent to hire a divorce lawyer such as Howard County, IN Divorce Lawyer to help ensure that the best outcome is achieved.
Whether you are receiving funds or giving them up, an understanding of the rules will help you know what to expect from asset division in a divorce. To ensure that the right party pays all applicable taxes, proper handling is crucial. The rules set out are determined by whether the type of retirement plan is a qualified plan or IRA. A divorce attorney will help you through the entire process so that you can focus on other things. A divorce is an extremely sensitive matter and a lack of attention to detail could make the entire process more expensive and complicated for you. However, this can be avoided with the help of a divorce attorney.
Qualified Domestic Relations Order Vs Transfer Incident to Divorce
During the divorce process, you are not required to pay taxes on the immediate retirement accounts division as long as they are filed with the courts correctly. A separate legal term applies even if you and your spouse divide the IRA and qualified plan assets in the same manner for each type of division. Transfer incident to divorce is the process through which IRAs are divided, whereas qualified plans like a 401(k) will be split under the Qualified Domestic Relations Order.
Courts can confuse between the two by simply labeling both types as QDROs, but a divorce attorney will handle the process for you. There is no need for you or your spouse to delineate between the categories for the retirement assets when submitting the information to the mediator or judge as the divorce attorney will take care of everything. Divorcees found doing this without a lawyer tend to make mistakes which leads to unnecessary complications that could have been avoided in the first place. Hence, the best course of action is to hire a divorce attorney to assist with the division of assets.
Division of a Qualified Plan (QDRO)
Qualified retirement plans are one of the few exceptions to protection from attachment or seizure by lawsuits or creditors that federal law accords for a divorce. A Qualified Domestic Relations Order can be used by the spouse to allow for the attachment of the qualified-plan assets under a divorce or separation decree. Such a decree can be used for the division of qualified-retirement-plan assets between its owner and his/ her current or ex-spouse, other dependents such as children. A divorce attorney will help you obtain a Qualified Domestic Relations Order in your favor or help ensure that one is not issued against you.
A Qualified Domestic Relations Order is similar to transfer incident to divorce as they are tax-free transactions if reported corrected to the IRA custodians and the courts. The spouse that receives the assets will have to roll the QDRO assets into her or his qualified plan or a traditional IRA.
However, keep in mind that any transfer from the qualified plan during the divorce settlement that is not considered a QDRO will subject to tax and penalty by the IRS.
Division of IRA: Transfer Incident
If the IRA division has been specified to be treated as a transfer incident to divorce in the agreement, then there will be no need to assess tax for the separation transaction.
Depending on how the decree has been worded and the circumstances of the division, the movement of funds might be classified as a rollover or a transfer by the IRA custodian.
Legal ownership of the assets will need to be taken by the recipient when the transfer has been completed. Then, they would assume the sole responsibility of tax consequences for all future distributions or transactions. It is important to hire a divorce attorney to assist in the splitting of the retirement funds and any other type of financial asset. Remember, if you do not hire a divorce attorney, you could fail to adequately label the division which would lead to tax liability and even an early withdrawal penalty on the amount given to your soon-to-be ex-spouse.
There is a need to provide instructions that satisfy both the receiving and sending IRA custodians, along with the state laws and the judge. If the courts do not approve the division agreement, the IRS would require an amended tax return to be filed which reports the entire amount as ordinary income. This could prove to be costly, but a divorce attorney will avoid this from happening.
Tracking the Basis of IRA Assets
A tax Form 8606 will also need to be filed with IRS if some qualified transfer incidents have been made from the IRA which was partially funded through non-deductible contributions to correctly calculate and report the non-deductible amounts. The divorce attorney will also help ensure that you make compliance.
It is important to add or update the beneficiaries after you have received or sent your IRA or qualified plan assets. Your ex-spouse would not be one of the beneficiaries unless the divorce decree states so. The divorce attorney will make sure to update the beneficiaries for all other financial assets such as life insurance and annuities.
Revocable Living Trust
If you are planning or getting remarried or if your children are going to be the primary beneficiary, then a revocable living trust should be created. The trust should be made the primary or second beneficiary of the account or plan. The divorce attorney might also help you with this or the attorney can have experience in estate-planning which would make the process a lot easier. It will help ensure that the retirement assets are dispersed in a manner that suits your needs.