Individual Retirement Accounts (“IRAs”), and “Keogh” plans are private retirement plans that do not fit in with other retirement plans, despite its similarities to a typical 401(k). Keoghs are essentially like other private retirement plans, but for sole proprietors, partnerships, or “S” corporations.
A “qualified domestic relations order”, or QDRO is not required to divide an IRA in a divorce action. All that is required is a simple order within the decree, or other order. However, there are a variety of special tax rules that affect how an IRA is distributed. These involve taxes and penalties for early withdrawal and the tax implications specifically relate to the kind of IRA involved. The two most prominent are “Traditional” IRAs and “Roth” IRAs.
Traditional IRAs are individual retirement accounts usually held by a bank or brokerage company that directs the investment of the deposited funds into specific stocks, bonds, or mutual funds (just to name a few). One of the primary attractions of the traditional IRA is that a specific portion (based on one’s tax bracket) of contributions made are tax- deductible. However, its primary drawback is that when it comes time to withdraw the funds, the individual is subject to federal income tax and possibly state and local taxes as well.
Although a QDRO is not necessary to divide a traditional IRA upon divorce, we suggest getting appropriate tax advice before any distribution is made from an IRA as the tax consequences may be significant.
Like Traditional IRAs, Roth IRAs are individual retirement accounts usually held by a bank or brokerage company that directs the investment of deposited funds into specific stocks, bonds, or mutual funds (just to name a few). However, Roth IRAs significantly deviate from Traditional IRAs because the money actually withdrawn is tax free. In other words, the individual foregoes a tax break when making contributions (Traditional IRA) for a tax-break upon withdrawal during retirement and some plans allow for withdrawal, tax free at any time.
Although a QDRO is not necessary to divide a Roth IRA upon divorce, we suggest getting appropriate tax advice before any distribution is made from an IRA as the tax consequences may be significant.
Does an IRA Require a QDRO?
When you split money in a divorce, among the first questions that comes up is, does an IRA require a QDRO? In truth, no, it doesn’t require one, and generally speaking, a QDRO can be a bad idea. This is because an IRA will be split according to your divorce agreement, not your QDRO.
Instead, when you split an IRA, the custodian of the IRA will be given a copy of the separation agreement or divorce decree. The best way to move these funds is generally to transfer the portion going to the former spouse by direct transfer to a new IRA in the former spouse’s name.
A QDRO applies only to a company retirement plan — a 401(k), 403(b), or similar plan. It doesn’t apply to an IRA. Exceptions apply to every rule, and it’s always best to get solid tax advice before you make any distribution, due to the potential tax consequences of the division.