Massachusetts divorces are often messy, but recent cases in the tax court remind us that that there are only two ways to make a tax-free transfer of IRA assets in a divorce proceeding.
One way is to simply change the name of the IRA to the ex-spouse. The other way is to directly transfer IRA assets to an IRA owned by the ex-spouse.
What you cannot do, however, is take a distribution from the IRA and transfer those funds to a checking account because that mistake can end up being very costly.
Investment advisors are needed to assist clients in transferring IRA funds to comply with the divorce decree’s terms.
The decree should be specific about how and when assets are split. If the IRA is invested in assets that fluctuate in value, the date that the IRA is divided may be critical. The divorce decree also should clearly state who is responsible for any fees and how they are paid.
If a divorce decree is unclear on any of these matters, an advisor may consider asking the court for more clarification. In rare circumstances, a divorce decree may need to be revised. Finally, don’t assume that your client’s divorce attorney is well versed in how IRAs should be handled in a divorce. This is a very specialized area, and mistakes are costly and often unfixable.
To get the ball rolling, the advisor or IRA owner should provide a copy of the divorce decree to the IRA custodian. Without this, the IRA custodian has no authority to move the IRA funds, so the custodian will want to see this document before proceeding with any transactions.
The IRA owner should then complete paperwork with the IRA custodian, authorizing a direct transfer of the IRA or the portion of it awarded to the ex-spouse. Because the account belongs to the IRA owner, the authorization must come from him to move the funds.
Also, the IRA owner is the one subject to the court order. If the ex-spouse already has her own IRA, the funds may be transferred to that account. If the ex-spouse does not have an IRA, then she will need to complete the necessary paperwork to establish one in order to receive the IRA funds awarded under the divorce decree.
The IRA custodian will then move the funds from the IRA to the ex-spouse’s IRA. This transaction is accomplished by a trustee-to-trustee transfer, in which the funds will move directly from one spouse’s IRA to the other spouse’s IRA.
There is no reporting issued to the IRS. Forms 1099-R and 5498 are not required because the transaction is handled as a transfer and not as a distribution and subsequent rollover. There are no tax consequences to the IRA owner or the ex-spouse due to the transfer of the IRA.
While some laws are unclear, and have gray areas, that is not the case here. The Tax Court has routinely held that taking an IRA distribution and then transferring those funds to an ex-spouse does not qualify as a tax-free transfer due to a divorce.
Divorces are already painful enough. Don’t make it worse by ignoring well-established tax law.
Should you be in the midst of a divorce or contemplating divorce, contact the Law Offices of Renee Lazar at 978-844-4095 to schedule a FREE one hour no obligation consultation.