Houston couples who choose to end a marriage have a lot to think about beyond how they feel about the break-up. Issues like child custody, spousal support and property division can be hot buttons for divorcing spouses. Conflicts over property separation are often magnified in a high net worth divorce.
During divorce, marital property must be added up and assigned a value. The task is not so easy when assets have changing values or are illiquid, like savings accounts that can't be touched without severe tax penalties until a certain age. Before any divorce agreement is reached, spouses must be aware of the tax consequences that might affect them.
The division of retirement plans takes more than an agreement between spouses. An extra legal step, a qualified domestic relations order or QDRO, sometimes is required to grant former spouse's rights to an ex's retirement benefits. The transfer of that money also can have tax implications for either spouse.
In one instance, a court ruled against a woman who received money from her former husband's 401(k) plan. A QDRO named the ex-wife as an alternate payee, responsible for any taxes on the amount. However, instead of rolling over the $103,000 directly to a tax-free savings plan like an individual retirement account, the woman opted to take the distribution.
She received a 1099-R from the plan administrator and reported the income to the IRS. The ex-wife claimed on her 2009 return that she owed no tax for the income because the money created a tax basis; the woman's former husband apparently owed her more than the distribution. The IRS promptly penalized the ex-wife for underpayment of federal taxes, and a court upheld the government's position.
Under other circumstances, the woman might have won the case. However, it's difficult to know the intricacies of retirement fund division rules and exceptions without the guidance of a financial or legal adviser.
Source: Investment News, "In divorce, retirement is at risk" Ed Slott, Jun. 08, 2014