The Tax Implications of Dividing Assets and Retirement Accounts in a Divorce

 Posted on August 25, 2023 in Division of Assets

The division of assets during and after a divorce can be a hard process. This is especially true when retirement accounts have major tax implications. As couples untangle their financial lives, retirement accounts can become a focal point, as they often make up a significant portion of a couple’s wealth. It is important to be aware of what can happen to your taxes when you divide assets during divorce so you can avoid unexpected financial troubles down the road.

How Dividing Assets Works in a Divorce

In general, the tax rules for dividing assets in a divorce are relatively simple. Under Section 1041 of the Internal Revenue Code, there is no tax on property transfers between spouses or former spouses.

However, some exceptions exist. If you get a distribution from a retirement account not qualified for rollover, you might have to pay taxes on earnings. Also, if you are younger than 59½ years, a 10 percent early withdrawal penalty could apply on any distributions from a retirement account.

There are specific rules for dividing retirement accounts in a divorce. For instance, with a traditional IRA, you will use something called a “transfer incident to divorce” to avoid tax consequences. Otherwise, it is like selling the account to your ex-spouse, possibly incurring taxes on gains.

What About Retirement Accounts?

For 401(k)s or other qualified retirement plans, it gets more complex. You will want to obtain a qualified domestic relations order (QDRO) from the court to avoid tax consequences. A QDRO is a legal document telling a retirement account administrator how to divide the retirement plan.

Other tips that can help you reduce tax implications include:

• Consider rolling over retirement accounts into IRAs to have more control and flexibility with investment decisions

• Delay distributions from retirement accounts until you are older to grow your savings and pay lower taxes on distributions

• Update beneficiaries of your retirement accounts to ensure assets go to the intended people in case of your death.

Always consult a tax advisor to understand possible tax implications when dividing assets and retirement accounts.

Contact a Naperville, IL Divorce Lawyer

By taking these steps, you can work towards a fair and equitable divorce while minimizing your tax liability. Remember, seeking professional guidance from a DuPage County, IL attorney at Calabrese Associates, P.C. can provide the clarity needed to move forward with confidence during this challenging time. Call the office at 630-393-3111 right now to discuss your options.

Source: https://www2.illinois.gov/sites/SRS/SERS/Resources/Pages/FAQ-QILDRO.aspx#qst5