Some older couples in Florida who are nearing retirement choose to divorce. When they do, they may have established IRAs or other retirement accounts with substantial savings that will need to be divided. If the people are under the age of 59 1/2 and have been taking substantially similar periodic payments from their IRAs, they need to understand how the division through the qualified domestic relations order might affect them.
Early withdrawal penalties
Under IRS rules, people who take distributions from their IRAs or 401(k) accounts before they reach age 59 1/2 will have to pay a 10% early withdrawal penalty. However, the IRS has carved out several exceptions to the early withdrawal penalty, including taking substantially similar periodic payments from their IRAs for early retirement. To avoid the early withdrawal penalty, the recipient cannot make any substantial modifications to his or her account and must continue taking substantially equal withdrawals each year.
When a person’s IRA is ordered to be divided in a divorce, the distribution to the ex-spouse is a modification to the account. This means that it might be subject to an early withdrawal penalty. The penalty can also be retroactively applied to each of the substantially equal periodic payments that have already been withdrawn. The IRS has provided letters of opinion in individual cases that indicate the division will not be treated as a modification, but opinion letters can be expensive to obtain and only apply to the individual taxpayer’s case who requests them.
Older adults who are planning to divorce and who have been taking substantially equal periodic payments from their retirement accounts might want to talk to divorce lawyers who are experienced in handling complex asset division cases. The lawyers may help their clients come up with solutions in their property division negotiations to avoid potential tax consequences. The lawyers may also be able to negotiate with the spouse who stands to receive a portion of the IRA account to accept other assets instead of taking from the account. The lawyers might also work closely with their clients’ financial advisors to help them protect their future abilities to retire comfortably.