Starting your first day at work, buying your first home, and seeing your newborn child are some of our most impactful firsts. Other firsts, like first spouse or the shock from the taxes taken from your first paycheck, tend to leave a different impact on us. Protecting ourselves from the latter can ensure we have more financial resources to focus on the former. Now, focusing on divorce and how your IRA might be affected, there are a few things to keep in mind.
First, IRAs are legally separated in divorce by something called a transfer incident to divorce as a part of the divorce agreement. This is vital for ensuring the tax status remains unchanged, while making it clear to the divorce court precisely what money is going to whom. It is important to note that IRA plan details are not altered in the event of a divorce.
Second, how assets are divided could be heavily influenced by the state you reside in and how it classifies marital property. Some states divide assets straight down the middle regardless of who purchased the asset. Other states divide assets proportionally based on the share of money spent to purchase the initial asset. The nine community property states in the U.S. are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Third, remember to change the beneficiary of your IRA after your divorce, unless you intend to have your IRA inherited by your ex-spouse at the time of your death. Yes, people go through a grueling divorce and yes, they remarry after finding the love of their life and yes, they forget to change their beneficiary to be their new spouse. This does happen, and courts will always award your IRA to whoever is listed as a beneficiary, even if you haven’t spoken to them in forty years.
Finally, if done correctly, there should not be any additional taxes or penalties levied on the retirement account of you or your ex-spouse. Signaling to the divorce court that a transfer incident of divorce has been created and everything has been delegated out should help keep this part of the process straightforward.