Few people plan for divorce. But it happens. And frequently, divorce involves the equitable division of retirement assets. The rules for Self-Directed IRAs are generally the same as those for conventional IRAs.
Generally, if one party gives up Self-Directed IRAs or other retirement assets to a spouse, there are no taxes or penalties on the transaction. Under Section 408(d)(6) of the Internal Revenue Code, the transfer of an individual’s interest in an IRA to a spouse or to a former spouse does not qualify as a taxable transfer.
However, whoever receives the assets from a spouse or former spouse takes on any future taxes or penalties that the assets generate.
So what do you have to do to qualify for tax-free treatment of retirement assets? IRC Section 71(a)(2) spell out what you need:
- A divorce decree from a court, including judgments of dissolution
- A decree of “separate maintenance”
- A written instrument incidental to a divorce decree.
Often, court orders dividing IRAs and other retirement assets come out as separate documents from the divorce decree.
What to do when you receive an order dividing an IRA
It’s normally a bad idea to take a distribution from an IRA in order to hand money over to a former spouse as part of the divorce. You would wind up with all the tax and penalty liability while the spouse gets the assets – and loses the benefit of the IRA’s tax-favored status forever.
Generally, a better idea is for the party receiving the assets to set up an IRA asset of his/her own and then set up a Trustee to Trustee Transfer from the grantor’s IRA to the recipients. This way the transaction gets treated as a transfer, rather than as a distribution.
The transfer can be in the form of cash, or it can be in the form of property.
Special considerations for Self-Directed IRAs
While the rules are the same, some Self-Directed IRAs are invested in very illiquid investments. Where this is the case, you may want to take some time and liquidate the IRA investment, however long it takes to get a good price, before transferring the asset. Normally, there shouldn’t be a rush, unless one party needs immediate income and needs to take a distribution. Even then, if the self-directed IRA asset is an income-producing asset such as rental real estate, it should be a simple matter to work something out that’s equitable to both sides.
When it comes to significant transactions – like transferring 50 percent of an IRA to a former spouse – working with a flat-fee self-directed IRA account administrator can provide enormous cost advantages. For example, while many financial institutions charge a percentage of the transfer – especially if you have to liquidate assets – American IRA, LLC charges only a small flat fee to handle the paperwork on the transaction. The difference can be worth thousands of dollars in fees and commissions.
American IRA, LLC is a national authority on the administration of Self-Directed IRAs and other retirement accounts. Our offices are in Asheville and Charlotte, North Carolina, but we work with clients in all 50 states and the U.S. territories. For more information on how to handle self-directed IRA assets during a divorce, or to learn more about the cost advantages of Self-Directed IRAs, call us today at 866-7500-IRA(472), or visit us on the Web at www.americanira.com.
We look forward to hearing from you.