Divorce and taxes: Dividing retirement savings when love hurts

When retirement plan assets are divided after a divorce, taxes can hurt. Learn how qualified domestic orders and post-divorce property transfers can help.

By: Alison Flores  /  February 13, 2020

Dividing assets in a divorce is a complicated financial issue. Retirement plan assets and the family home often represent some of the most valuable assets a couple owns. Splitting these assets can be contentious and involve attorneys, financial planners, and tax advisors. The tax implications of dividing retirement plan savings because of divorce can be complicated and vary based on the kind of property the former spouse receives.

Qualified domestic relations order (QDRO) for employer retirement plans

If a plan participant simply takes a retirement distribution and writes a check to the former spouse, the plan participant will owe income taxes on the distribution (and 10% additional tax if it is an early distribution), not the former spouse. The plan participant will receive Form 1099-R and report the taxable income and any additional tax on their federal income tax return.

To move the responsibilities for income and early distribution taxes to the recipient spouse, the plan participant can use a qualified domestic relations order (QDRO). A QDRO is a court order that gives rights to an alternate payee (usually the former spouse). A QDRO specifies the benefits to be paid to the alternate payee. A QDRO may relate to marital property rights, child support, or alimony.

When a QDRO is used to transfer assets to an alternate payee who is a former spouse, the former spouse will receive Form 1099-R and report any taxable income on the distribution. The 10% additional tax on early distributions never applies when a distribution is made pursuant to a QDRO. The age of the participant and the alternate payee do not impact the original QDRO distribution. However, if the alternate payee rolls over the distribution to an IRA, a later distribution may be subject to the 10% additional tax.

Because of the complexity involved in drafting a QDRO, and the differences among plan rules and payout options, it’s generally advisable to consult an attorney for assistance with a potential QDRO.

In summary: transferring plan assets using a QDRO is essential to ensuring the recipient spouse is liable for tax on any retirement plan distributions they receive.

Similar tax impacts can be accomplished under some plans sponsored by federal, state, or city entities and tax-exempt organizations. While these plans may not utilize the QDRO procedure, an attorney can help determine what options are available for these plans to accomplish similar results.

Transferring individual retirement arrangement (IRA) assets pursuant to a divorce decree

Similarly, if an IRA owner takes a distribution and simply writes a check to the former spouse in a divorce, the IRA owner will receive Form 1099-R and report the taxable income and any additional tax on their federal income tax return, not the recipient spouse.

Unlike employer plans, QDROs cannot be used for IRAs. Instead, an IRA can be divided between former spouses by directly transferring assets from the original owner’s IRA to the IRA of the former spouse. The transfer must be made pursuant to a divorce decree or legal separation agreement. When this occurs, the transfer is tax-free. The recipient spouse is subject to tax on subsequent distributions. The 10% additional tax would apply to subsequent distributions if the recipient spouse is not yet 59 ½. For traditional IRAs, a recent change means required minimum distributions (RMDs) would first be required when the recipient spouse attains age 72.

If the original IRA owner had basis in any IRAs, basis for the benefits transferred must be allocated to the recipient spouse. Basis should be allocated based on the value of the IRA the recipient spouse receives and the entire value of the original IRA owner’s IRAs.

Rollovers to a former spouse’s IRA

Former spouses may also rollover the QDRO benefits to their own IRA, or may rollover from an IRA to another IRA. A rollover may be accomplished easily through a trustee-to-trustee transfer.

If a trustee-to-trustee transfer is not utilized, a rollover from a qualified plan to an IRA, or an IRA to an IRA, may only occur if the distribution is rolled over within 60 days of receipt. But because distributions not made through a trustee-to-trustee transfer are generally subject to 20% withholding, an individual attempting a rollover on their own, needs to consider how and whether they can restore withholding on the distribution with cash from another source.

QDRO transfers may be more advantageous under new alimony rules

A recent change in how alimony payments are treated for tax purposes may make use of QDROs more advantageous for some taxpayers than alimony. Here’s the change and its effect.

For divorce decrees finalized before 2019, alimony payments are deductible by the paying spouse and reported as taxable income by the recipient spouse. This is like the tax treatment of retirement plan distributions under a QDRO.

For divorce decrees finalized after 2018, alimony payments are not deductible by the paying spouse, and the recipient spouse does not pay taxes on alimony. Because the paying spouse is generally subject to higher tax rates than the recipient spouse, it may be advantageous to consider using a QDRO rather than alimony to shift tax liability.

Divorce and social security retirement payments

Social security is an important component of retirement income streams, yet cannot be divided like other types of plan assets. QDROs can’t be used to divide social security retirement payments.  However, taxpayers who were married 10 years or longer may be eligible to receive benefits based on their ex-spouse’s record after divorce. This is possible if the benefits an individual is entitled to receive based on their own work are less than they would be eligible to receive based on their ex-spouse’s work. The maximum benefit based on the ex-spouse’s work is equal to one-half of the ex-spouse’s full retirement amount.

For more information about Social Security retirement payments based on an ex-spouse’s work, see “If You Are Divorced” and “Benefits For Your Divorced Spouse” from the Social Security Administration.

Conclusion: We can help

Sometimes, love hurts. Unexpected tax bills are painful especially after the dust settles on a divorce proceeding. Taxpayers considering divorce or in the process of divorcing should work with their legal and financial team to understand how splitting up retirement savings will impact their taxes and their retirement income stream. Not sure how divorce could impact returns? Find one of our experts to help today.

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Author Name

Alison Flores

Alison Flores, JD, is a principal tax research analyst at The Tax Institute at H&R Block. Alison specializes in the Tax Cuts and Jobs Act (TCJA) and individual income tax issues.

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