An area where many individuals get into tax trouble is when splitting their Qualified Retirement Accounts (QRPs) and Individual Retirement Accounts (IRAs). Once you have come to the revelation that your assets must be split you may be tempted to start the process by making pre-divorce transfers prior to receiving an official judgment, decree or court order. This is especially tempting in community property states. Sometimes couples think they can save professional fees (legal and/or financial) by prematurely starting the process of dividing retirement assets. This can be a costly mistake. The same can be said for making post-divorce transfers.

The importance of this is best illustrated with an example.
Pre-Divorce IRA Distribution Example

Let's assume that spouse A has $100,000 in an Individual Retirement Account (IRA) and spouse A and spouse B agree to split the IRA 50/50. Spouse A takes a distribution in the amount of $50,000 and then writes a check to spouse B for $50,000 and spouse B rolls-over the amount into his own IRA within the 60 day time limit. At the time that the distribution occurred, spouse A had not received a judgment, decree or court order requiring the distribution. This type of scenario would produce a very negative tax situation for spouse A and spouse B would receive a cash windfall of $50,000.

From a tax perspective, the initial amount withdrawn of $50,000 would be considered a fully taxable distribution to spouse A. Spouse A would be liable for the income taxes associated with this distribution. If spouse A is in the 25% tax bracket, the potential liability to spouse A would be $12,500. Also, if spouse A is under the age of 59 ½ at the time of withdrawal, an additional tax of 10% would be levied for a premature withdrawal which would equate to an additional $5,000 of taxes. Spouse A could end up with a tax bill for $17,500, give up $50,000 in retirement funds, and spouse B would receive $50,000 tax free. Technically, the rollover to spouse B's IRA would not qualify. Spouse B would probably not complain in this situation, but it would be an inequitable solution.

As you can see, a simple transaction with good intentions could turn out to be very inequitable to one spouse. We cover several retirement split examples in our eBook "The Financial Divorce - Your Guide to Financial Divorce Knowledge". For more financial considerations visit our site at www.financialdivorceblog.com

Author's Bio: 

David has over 19 years of experience in dealing with complex financial issues and has represented numerous individuals and businesses with an emphasis on developing financial systems, advising on taxation issues, representing individuals before the Internal Revenue Service, performing business valuations, and training individuals in various financial topics. He received his BBA from Ohio University in1990 and earned his CPA in 1992. He is married and has two daughters and three step-sons. You can visit his blog at www.financialdivorceblog.com for more information.