Your retirement accounts, such as 401ks, are typically safe in bankruptcy and cannot be used to pay creditors. Traditional IRAs and Roth IRAs are protected up to a limit (currently more than $1 million). However, a U.S. Circuit Bankruptcy Court of Appeals recently ruled that when retirement assets are divided in a property settlement in a divorce, these assets are not protected from creditors. The Court’s opinion stated that the exemption from bankruptcy is limited to the individuals who create and contribute funds to the retirement accounts. This article summarizes the Court’s ruling.
There are some special considerations for splitting IRAs pursuant to a divorce. Unlike qualified retirement plans, you do not need a qualified domestic relations order (QDRO). However, the split must be addressed by a divorce decree. If an IRA is split before the divorce decree is issued, you can be subject to taxes and penalties. Have a look at this article for more information.
In order to divide qualified retirement assets, such as a 401(k), profit sharing plan, or defined benefit plan, a qualified domestic relations order (QDRO) will be a necessary document. This article explains the tax implications when such a division is made improperly without a QDRO. On the other hand, QDROs are not used to divide an IRA, whether a traditional IRA, Roth IRA, SEP IRA, or Simple IRA. Instead, the divorce decree must specifically lay out the terms for such a division.
Following equity in the marital home, retirement plan assets usually represent a large chunk of the marital assets. Splitting the retirement plan assets is accomplished by using a qualified domestic relations order (QDRO). Depending on the type of plan, the ex-spouse of the plan participant rolls over her/his share of the retirement plan assets into an IRA. If funds are needed post-divorce, the ex-spouse is also allowed to take an early distribution without a penalty if under age 59 ½. However, taxes will have to be paid on the distribution. Read this article for additional tips on managing retirement assets post-divorce.
Even though this article is more pointed towards our CPA friends, we at SDF work with QDROs and accountants, all within the divorce financial planning process. Remember, there are a number of interesting and tax-effective ways to take cash from a retirement plan. This must be done carefully and on a coordinated basis with the other professionals on the team. We can show you how! See the full article from Accounting Today here.