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Order Transferring IRA Subject to Divorce.


Thornton
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H and W divorce. Both are under 59 1/2. H is awarded $11,000 from W's IRA. He does not intend to roll it over. An Order Transferring IRA Incident to Divorce (similar to a QDRO) is drafted, signed by H and W and approved by the court. If this were a distribution from a qualified plan under a QDRO, H would include the distribution in his income but would not be subject to the 10% early withdrawal penalty. Question: Is H subject to the penalty tax here? 

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I could be wrong but I though when an IRA was split in Divorce the funds got transferred from the existing IRA owner to the alternate payee IRA owner and then if they came out of the alternate payee IRA the were treated like any IRA distribution. That is under 59.5 would be subject to 10% penalty.

I think the exception to the 10% penalty is only in the case of Qualified Plan that pays directly to alternate payee per QDRO.

But my understanding could be off, IRAs are not my specialty.

 

 

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That not the way it is done.  In order to avoid taxes and penalty being imposed on the account holder, there must be a rollover and not a direct distribution to a former spouse.  See the Gorin article "IRAs: DIVISION AND TRANSFER INCIDENT TO DIVORCE" below.  The IRA transfer must be from the wife's IRA to the husband's  IRA and then the husband can take a income taxable distribution that may or may not be subject to the 10% penalty.  

The way you have it set up the wife will be making a distribution and the wife will pay income taxes and a 10% penalty on the payment to the husband.  And the Plan will withhold 20% for Federal taxes.    

An Alternate Payee is not subject to the 10% early withdrawal penalty if the distributions are under a QDRO in an ERISA  qualified plan. See IRC 72(t)(2)(C).  And see this website discussing the exceptions to the imposition of the 10% penalty:
https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions
See also - https://www.irs.gov/taxtopics/tc558.html

But see the strange T.C. Memo. 2017-125, Summers v. Commissioner at -
https://scholar.google.com/scholar_case?case=4327573022055470859&q=T.C.+Memo.+2017-125&hl=en&as_sdt=20000006 that seems to suggest that an IRA can be  exempt from the 10% penalty is transferred pursuant to a domestic relations order as defined by IRC §414(p)(1)(B) which related only to ERISA plans and not to IRAs.

Note that most IRA custodians no longer require a Court Order.  They believe they can make a direct non-taxable transfer of funds from the IRA account holder to the former spouse's IRA using their own forms.  See for example the attached from various custodians.   

Also attached are some articles that deal with the subject of transferring IRAs in a divorce.   

 

Equitable IRA Transfer Form.pdf TD Americtrade IRA Transfer - Divorce.pdf Schwab IRA Divorce Transfer Request Form.pdf American Funds IRA Transfer Form.pdf Morgan Stanley IRA Transfer Form.pdf Vanguard IRA Divorce #2.pdf T Rowe Price IRA DivorceTransfer Form.pdf Alliance Bernstein IRA Transfer Form.pdf Divorce Source_ DIVIDING IRAs IN DIVORCE.pdf +++IRAs_ Division and transfer in.pdf IRA - 19 Ways to Withdraw IRA Funds Without Penalty.pdf IRA DC and More Retirement Topics Tax on Early Distributions IRS.pdf IRA TaxFreeTransfer - Fidis.pdf IRA Transfer w-o Court Order.pdf

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On 11/30/2021 at 4:31 PM, Lou S. said:

I could be wrong but I though when an IRA was split in Divorce the funds got transferred from the existing IRA owner to the alternate payee IRA owner and then if they came out of the alternate payee IRA the were treated like any IRA distribution. That is under 59.5 would be subject to 10% penalty.

I think the exception to the 10% penalty is only in the case of Qualified Plan that pays directly to alternate payee per QDRO.

But my understanding could be off, IRAs are not my specialty.

 

 

Your understanding is correct. The only thing I would change is the use of the term 'alternate payee', as that applies to QDROs ( not transfer due to divorce , for IRAs)

Edit to add: The 10% penalty would not apply if the recipient spouse qualifies for an exception that applies to IRAs.

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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