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# 5 - IRAs: Division and transfer incident to divorce.

Monograph # 5                                                                       Rev. 1.7

IRAs:  DIVISION AND TRANSFER INCIDENT TO DIVORCE

© Lawrence D. Gorin, Attorney at Law, Beaverton, Oregon

    As a general rule (but subject to a number of exceptions), when there is a withdrawal or distribution of money from a traditional IRA (individual retirement account), the amount withdrawn or distributed is taxable to the IRA account owner for the year of receipt and, if done prior to the account owner attaining age 59½, will be subject to an additional 10% “early withdrawal” penalty.

    However, when all or a portion of an IRA account owned by one spouse is awarded to the other spouse as part of the property division aspects of a divorce, the tax consequences otherwise imposable on the account owner at the time of divorce, including the 10% “early withdrawal” penalty, can be avoided by accomplishing the division of the IRA by a transfer (rather than withdrawal or distribution) of the IRA, as authorized by IRS Code Section 408(d)(6).

26 USC § 408(d)(6).  Transfer of IRA incident to divorce:

          “The transfer of an individual’s interest in an individual retirement account or an individual retirement annuity to his spouse or former spouse under a divorce or separation instrument described in subparagraph (A) of section 71(b)(2) is not to be considered a taxable transfer made by such individual notwithstanding any other provision of this subtitle, and such interest at the time of the transfer is to be treated as an individual retirement account of such spouse, and not of such individual. Thereafter such account or annuity for purposes of this subtitle is to be treated as maintained for the benefit of such spouse.”

    NOTE:  Subparagraph (A) of section 26 USC § 71(b)(2) describes a “a divorce or separation instrument” as meaning “a decree of divorce or * * * a written instrument incident to such a decree.”

      A “transfer” of an IRA incident to divorce in accord with 26 USC § 408(d)(6) is different from an IRA “withdrawal” or “distribution.”  When drafting legal documents and when dealing with financial institutions, it is important to use the correct terminology.  Failure to do so may result in confusion as well as unanticipated and unwanted consequences.

     In sum, 26 USC § 408(d)(6) allows for all or part of an existing IRA to be transferred to the IRA owner’s spouse or former spouse, incident to divorce, without immediate tax consequences to either party, so long as certain requirements are met.  Once the transfer is accomplished, the portion of the IRA transferred to the former spouse becomes the former spouse’s own IRA, with the former spouse then being responsible for tax liabilities resulting from future withdrawals from the IRA, including the 10% tax penalty if money is withdrawn by the former spouse prior to attaining age 59½.

    To avoid tax liabilities that would otherwise arise at the time of dissolution in connection with the division and transfer of an IRA, 26 USC § 408(d)(6) imposes two basic requirements:

    First.  There must be a “divorce or separation instrument.”  This requirement is satisfied by a judgment of dissolution of marriage, a judgment of legal separation or separate maintenance, or a written instrument incident to such a judgment.  The divorce or separation instrument must contain a provision that awards or grants all or part of one spouse’s interest in an existing traditional IRA to the other spouse.  The IRA should be specifically identified by name and account number.   Suggested language for inclusion in the dissolution judgment is set forth below.

    Second.  There must be a transfer to the IRA owner’s former spouse of the interest in the IRA (or the portion thereof) as specified in the divorce or separation instrument.  (Again, a "transfer" pursuant to IRS Code § 408(d)(6) is not a withdrawal or distribution, both of which are different from a transfer.)

Two transfer methods

    There are two methods for transferring an IRA to a former spouse incident to a divorce.  The methods are:

    1.  Changing the name on the IRA.  If the entire IRA is to be transferred, the transfer can be accomplished by simply having the IRA account owner change the name on the IRA from his/her own name into the name of the former spouse.  Thereafter, for all purposes, the former spouse is the owner of the IRA.

    2.  Direct transfer.  Under this method, the IRA account owner directs the IRA custodian or trustee (whether a bank, trust company, brokerage firm or insurance company), to transfer a fixed dollar amount or a percentage of the owner’s IRA directly to the trustee or custodian of a new or existing traditional IRA established in the name of the former spouse.  

    In both situations, as earlier stated, once the transfer is complete, the former spouse, i.e., the transferee spouse, may then withdraw funds from the transferee's IRA.  Such withdrawals (unless qualifying for an exception) will be subject to regular income taxation as well as the 10% penalty if the withdrawal occurs prior to age 59½.

No QDRO needed for transfer of IRA incident to divorce; however........

    The transfer of an IRA incident to divorce does not require the use of a qualified domestic relations order (QDRO).  A QDRO, as defined in the Internal Revenue Code at 26 USC § 414(p) and in the Employee Retirement Income Security Act (ERISA) at 29 USC § 1056(d)(3), is required by federal law to implement the court-ordered division of a spouse’s (or former spouse’s) interest in an employer-sponsored  qualified retirement plan such as a pension, profit sharing or 401(k) plan.  An IRA (being an “individual” arrangement) is not an employer-sponsored qualified retirement plan and is not subject to QDRO requirements.

    However, even though federal law does not require the use of a QDRO to accomplish the division and transfer of an IRA incident to divorce, many IRA custodians and trustees nonetheless require that a copy of the dissolution judgment (or relevant pages thereof), or a specific court order separate and apart from the dissolution judgment, be submitted as a prerequisite for implementing the IRA transfer.  It is not unlawful for an IRA custodian or trustee to impose such a requirement.  If a separate court order is prepared for this purpose in conjunction with an Oregon dissolution of marriage, the order should appropriately be titled as a Supplemental Judgment (Transfer of IRA Incident to Dissolution of Marriage).  

    Further, many IRA custodians and trustees require that the account owner’s directive to transfer IRA funds to an IRA owned by the former spouse be in the form of a “Letter of Instruction” (or similar document), often with the further requirement that the account owner’s signature be “guaranteed” (meaning “gold medallion signature guarantee” by a commercial bank or other authorized securities firm).  Some IRA custodians and trustees also require that the former spouse establish an IRA in his or her own name within the same financial institution (if such does not already exist) so that an “internal transfer” can be accomplished.  Once done, the former spouse will then be able to direct that the IRA funds be transferred to an IRA of the transferee spouse at some other financial institution, if so desired.

    Also, many financial institutions nowadays have "IRA Distribution/Transfer Request" forms (with instructions) that are readily available at their Internet websites.  It is therefore advisable to check with the financial institution's website for details.

    The requirements imposed by IRA custodians and trustees are varied and numerous, and sometimes onerous.  Also, there is no “standard form” of court order or supplemental judgment for directing the division and transfer of an IRA incident to dissolution of marriage.  Practitioners are advised to check with the IRA custodian or trustee to ascertain the specific requirements that the IRA custodian or trustee wants to have satisfied as a prerequisite for implementing the transfer of funds to the account owner’s former spouse.  The court order (in the form of a supplemental judgment) should then be drafted accordingly.  At a minimum, the supplemental judgment should contain language ordering the IRA owner to execute and furnish to the former spouse such documents as may be specifically required by the IRA custodian or trustee in order to implement the division and transfer of IRA funds to the former spouse.

Suggested language for dissolution judgment

    Practitioners may want to consider the following language for inclusion in marital dissolution judgments involving the award and division of an IRA:

        “Wife is awarded [$________] or [ _______%] of husband’s individual retirement account (IRA account # _____________) with ______________ Investment Services Co. as of ____________, 2011, adjusted so as to account for earnings, gains and losses, if any, thereon from said date to the date of actual division and transfer.  The foregoing award shall be implemented by a transfer of funds directly from the aforesaid IRA to a new or existing IRA established in wife’s name, as wife shall designate, in accord with 26 USC § 408(d)(6).  Husband shall promptly and properly execute and furnish to wife such transfer documents, forms, letters of instruction, authorizations, consents and similar instruments as may be needed to implement the aforesaid award.  The court retains jurisdiction to enter such supplemental judgments as may be necessary to effectuate the award herein made to wife.”

Additional resources

IRS Publication 504 -- “Divorced or Separated Individuals”
    http://www.irs.gov/pub/irs-pdf/p504.pdf
    http://www.irs.gov/publications/p504/index.html

IRS Publication 590 -- “Individual Retirement Arrangements (IRAs)”
    http://www.irs.gov/pub/irs-pdf/p590.pdf
    http://www.irs.gov/publications/p590/index.html

Dividing IRAs in Divorce” (from National Legal Research Group, Inc.)
    http://www.divorcesource.com/research/edj/pensions/01jan1.shtml

=====================================
LAWRENCE D. GORIN
Attorney at Law
6700 S.W. 105th Ave., Suite 320
Beaverton, Oregon 97008
Phone:  503-716-8756
Fax:    503-646-1128
E-mail:  LDGorin@pcez.com
Website: http://ldgorin.justia.net/index.com