Timing of the Transfer
Under 26 U.S. Code §1041, you typically have a 6-year window of time from the date your divorce is finalized to make a transfer that is not subject to taxation. Once you go beyond 6 years, you are looking at two individuals that are divorced, transfer assets between each other could be considered a gift subject to different rules. Unless there is a valid reason that is beyond your control, the sooner you complete the transfer the better off you will be. Because the code specifies that the tax-free transfer must be incident to divorce, it may also help to include what the other spouse will receive under the divorce agreement.
Key Takeaways
- Under 26 U.S. Code §1041, you typically have a 6-year window of time from the date your divorce is finalized to make a transfer that is not subject to taxation.
- Often times, retirement plans must be divided to pay out a divorcing spouse. However, you would be wise to approach this task with caution.
- You can avoid this hefty pre-payment penalty by having a Qualified Domestic Relations Order (QDRO) prepared, and then submitted to the court to be executed.
Dividing Retirement Plans
Often times, retirement plans must be divided to pay out a divorcing spouse. However, you would be wise to approach this task with caution. Withdrawing payments from your IRA or 401k can come with a 10% penalty if done before a certain age––– typically 59 and a half years old.
You can avoid this hefty pre-payment penalty by having a Qualified Domestic Relations Order (QDRO) prepared, and then submitted to the court to be executed. The court will send the QDRO to your retirement plan administrator–– they prepare and divide the account; the money can then be withdrawn by the alternate payee. But be sure not to withdraw the money prior to the completion of the process, otherwise you will lose the provision which allows you to access the funds penalty-free.
Another item you should consider with regard to retirement plans, is whether there are any outstanding loans that you may have taken out against your retirement funds. While a loan taken out on your 401k is normally tax-free, if you borrow money from a 401k plan and then liquidate the 401k account; you are likely going to have to pay the taxes on the funds that you withdrew.
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