Yes, you can divide your retirement account in a divorce without paying taxes if you structure the transaction properly at the time of division regardless of the type of account.
The process for a tax free division in a divorce depends on the type of retirement account that you are dividing.
But first, let’s discuss when a division would be taxable as part of your divorce.
Withdrawals and Distributions Are Taxable In A Divorce
In some cases it might be tempting to simply take an early withdrawal from your retirement account then cut a check to your spouse as part of the property division in your divorce.
Taking the withdrawal or distribution from your retirement account is a taxable event – meaning that you would owe taxes (and likely a penalty as well) for the amount of the withdrawal.
Since you took the withdrawal, you owe the taxes – even though you gave the money to your spouse as part of the divorce settlement.
Now, if you divided that same account through one of the tax free methods discussed below and your former spouse made the withdrawal after the divorce – then your spouse is liable for the taxes as well as any penalty for an early withdrawal.
Tax Free Division Of An Individual Retirement Account (IRA)
Individual retirement accounts are the easiest type of account to divide tax free in a divorce.
The only requirement to divide the account is that the final decree of divorce award a specific portion of the account, whether as a percentage or specific amount, to your spouse.
You then take the final decree to the financial institution managing your IRA. That institution will setup a new IRA in your former spouse’s name then rollover the specified portion of your IRA account into your former spouse’s IRA.
This rollover is done tax free as it is not a withdrawal or distribution.
Tax Free Division Of A 401(k) or Pension Plan
Achieving a tax free division of your 401(k) or pension type plan requires more effort.
In order to divide these types of retirement accounts tax free as part of your divorce, the division must be done pursuant to a Qualified Domestic Relations Order (“QDRO”).
A QDRO is a separate order issued after or at the same time as your final decree. The QDRO provides specific instructions to the plan administrator on how, when, and in what amount your retirement account should be divided.
You must custom draft each QDRO to the specific type of plan and in accordance with the specific plan documents and rules adopted by your employer’s retirement plan. This is why the QDRO route is more complicated and expensive than dividing an IRA.