Understanding the Tax Impact of IRA and 401(k) Division in Divorce

Dividing retirement accounts such as IRAs and 401(k)s in a divorce can be complicated, especially when it comes to tax implications. One common issue that arises is whether these assets should be “tax-effected” when equitably dividing them between spouses. Some attorneys argue that their client should receive more in the division due to future tax liabilities upon withdrawal, but is this always justified?

When Should Retirement Accounts Be Tax-Effected?

The general rule in Florida family law is that when dividing retirement accounts equally between spouses, tax implications are not typically factored in because both parties will eventually pay taxes when they withdraw the funds. However, there are exceptions.

1. If the Retirement Account is Being Exchanged for a Non-Taxable Asset

If one spouse is keeping a retirement account while the other is receiving a different asset, such as a home, bank account, or investment that is not subject to future taxes, it is reasonable to adjust the division based on the “net” value of the retirement account after anticipated taxes.

Example:

• Spouse A keeps a 401(k) worth $100,000.

• Spouse B keeps a house worth $100,000 (fully paid off).

At first glance, this seems like an equal split, but the 401(k) will be taxed when withdrawn, while the home is a non-taxable asset. If Spouse A has to pay approximately 22% in taxes upon withdrawal, their actual “net” value would be around $78,000. In this case, it may be reasonable for Spouse A to receive additional assets to make the division fair.

2. If the Retirement Account is Simply Being Split Between Spouses

If both spouses are receiving a portion of the retirement account, then no tax effect should be applied because both will face the same tax liability when they withdraw their shares.

Example:

• A 401(k) worth $200,000 is divided 50/50 between Spouse A and Spouse B.

• Each receives $100,000.

Since both parties will pay taxes on their respective portions, it would not be appropriate to claim one spouse should receive more in the divorce settlement due to future tax burdens.

Using a QDRO to Divide a 401(k) Without Penalties

A Qualified Domestic Relations Order (QDRO) is the legal document used to divide a 401(k) or pension plan in a divorce. Here's what spouses need to know:

• The non-participant spouse (alternate payee) can roll over their share into an IRA to avoid immediate taxes.

• If the alternate payee withdraws the funds immediately, they will owe income taxes, but they won't have to pay the 10% early withdrawal penalty (if done through the QDRO).

• If the alternate payee rolls over the funds into an IRA and then later withdraws, they will be subject to the 10% penalty if they withdraw before age 59½.

Example:

• Spouse A has a 401(k) worth $300,000.

• A QDRO awards Spouse B $150,000.

• If Spouse B withdraws the $150,000 immediately, they will owe taxes but no penalty.

• If Spouse B rolls it into an IRA and withdraws later before 59½, they will owe taxes and a 10% penalty.

Key Takeaways

1. If a retirement account is being exchanged for a non-taxable asset, it may be reasonable to adjust for taxes.

2. If both spouses are splitting the retirement account, it should not be tax-effected since both will face the same tax consequences.

3. Using a QDRO correctly can help avoid penalties if a spouse needs access to the funds before retirement.

4. Working with an experienced attorney can ensure retirement accounts are divided correctly and fairly.

If you need help with aspects of your divorce, Family Matters Law Group, P.A. is here to assist you. We specialize in handling complex asset division and ensuring that you get a fair outcome. Contact us today to discuss your case!