How Do You Transfer an IRA Incident to Divorce?

Dividing assets during a divorce often involves complex financial decisions, particularly concerning retirement accounts. An Individual Retirement Account (IRA) is a common asset that must be addressed. A transfer incident to divorce allows for the division of an IRA between spouses without immediate tax consequences, provided specific rules are followed. This process is distinct from other asset divisions and requires careful attention to legal and financial requirements to ensure a smooth and compliant transfer.

Tax Treatment of the Transfer

A properly executed transfer of IRA assets to a former spouse is a non-taxable event under Internal Revenue Code Section 408(d)(6). This rule stipulates that if an individual’s interest in an IRA is transferred to their spouse or former spouse under a divorce or separation instrument, it is not a taxable transfer. The transferring spouse does not include the amount in their gross income and is not subject to the 10% additional tax on early distributions.

This favorable tax treatment is contingent on the funds moving directly from the transferring spouse’s IRA to an IRA established for the receiving spouse. If the original account owner withdraws the funds and then gives cash to their former spouse, the transaction is treated as a taxable distribution. This would trigger both ordinary income tax and the 10% early withdrawal penalty if the owner is under age 59.5.

Once the assets are in the recipient’s IRA, they are treated as if they had always been theirs. Any subsequent distributions from this new IRA will be included in the recipient’s gross income and subject to standard IRA rules.

Required Documentation and Information

Successfully transferring IRA assets requires specific legal and financial documentation. The process hinges on a formal court document that mandates the division of the account, as financial institutions cannot act without this legal authority.

Legal Mandate for Transfer

The transfer must be required by a divorce decree or a written instrument incident to the divorce, such as a court-approved property settlement agreement; an informal agreement is not sufficient. Unlike employer-sponsored plans like 401(k)s, IRAs do not use a Qualified Domestic Relations Order (QDRO). The language in the divorce decree must be specific, clearly identifying the IRA by financial institution and account number. The document must also specify the exact dollar amount or percentage to be transferred and name both individuals involved.

Financial Institution Requirements

Each financial institution, or IRA custodian, has its own set of forms and procedures for processing a transfer incident to divorce. The transferring spouse must complete this paperwork to authorize the transfer. The forms will require the personal information of the receiving spouse, such as their full name and Social Security number. It also requires the account number of the IRA that will receive the funds, as the receiving spouse must have their own IRA ready to accept the assets.

The Transfer Process

After completing all necessary legal and financial paperwork, the next phase is the execution of the transfer. This involves submitting the documents to the financial institution and ensuring the transaction is processed as a direct movement of assets.

You will need to submit a package including a copy of the relevant pages from the divorce decree and the custodian’s transfer authorization forms. The transfer must be structured as a direct “trustee-to-trustee” transfer. This means the financial institution holding the original IRA sends the assets directly to the institution holding the recipient’s IRA.

At no point should either spouse take possession of the funds, as an indirect rollover where a check is made out to the spouse does not qualify for the tax-free treatment. Once the paperwork is submitted, processing times can vary but typically take several weeks. The custodian will then transfer the assets “in-kind” or as a cash value to the recipient’s IRA as specified.

Post-Transfer Account Management

Once the transfer is complete, the awarded assets are legally the property of the recipient spouse and are held in their own IRA. The account is governed by all standard IRA rules as they apply to the new owner, who is treated as the original owner.

This means any future distributions from the IRA will be taxed as ordinary income to the recipient. If the recipient takes a distribution before they reach age 59.5, they will generally be subject to a 10% early withdrawal penalty, unless a specific exception applies.

The recipient spouse should also manage their new account by reviewing investments to ensure they align with their financial goals. It is also important to designate new beneficiaries, as any previous designations do not carry over.