Tuesday, September 13, 2011

Divorce and IRAs

Under Federal law, an employee's interest in a qualified retirement plan (such as a defined benefit plan or a 401(k) plan) cannot be transferred to another person during the employee's lifetime. A major exception is a transfer under a Qualified Domestic Relations Order (QDRO). These are complex documents which must be drafted in compliance with a number of statutory and regulatory requirements, and must be entered by a court and accepted by the pension administrator before they can become effective.

Because IRAs are not qualified retirement plans (as that term is used in the Internal Revenue Code), they are not proper subjects of QDROs. Many lawyers who do divorce work will try to create a QDRO for an IRA, and many courts will enter them, unaware that the QDRO rules do not apply to IRAs.

The good news is that there is a statutory provision for the transfer of a participant's interest in an IRA, and the rules are much simpler than they are for QDROs. Section 408(d)(6) of the Code governs "transfer incident to divorce". It provides that the transfer does not result in the recognition of income, and that the account thereafter is to be regarded for all purposes under the Code as the IRA of the spouse. That means (among other things) that the funds held in the account cannot be withdrawn before the spouse turns 59½.

The requirements are:
  • The account must be transferred, not distributed. If the funds are paid from the account, it is a distribution, and this is a taxable event. A distribution from the account cannot be rolled over, as with an rollover from a qualified plan to an IRA.
  • The transfer must be ordered by a court, in
  • a decree of divorce
  • a decree of separate maintenance, in states which recognize such decrees
  • a written agreement "incident to" (incorporated in) a judgment of divorce or separate maintenance
  • A written separation agreement or a court's support order which is not incorporated into one of the orders identified above is not sufficient to meet the requirements of Section 408(d)(6).
Otherwise, there are no formalistic requirements. The following is satisfactory language for Michigan residents:
"It is further ordered that the interest of the Husband in the Individual Retirement Account number 94-98334 maintained with the Michigan National Bank is hereby transferred to the Wife and shall be held as her account as provided in Section 408(d)(6) of the Internal Revenue Code."
If it is determined that an account should be split between husband and wife, the IRA should be divided before the transfer is made. An assignment of a partial interest is not recognized under the Code.

The transferred account would best be entitled with a notation of the transfer, e.g., "Susan Smith, as transferee of John Smith". The Social Security number of the spouse should be used, since she will be receiving the distributions once she is eligible.

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