Can an IRA Be Cashed Out During a Divorce?

In a legal separation or divorce, IRAs get divided using a “transfer incident to the divorce.” Unfortunately, the Internal Revenue Service does not consider divorce as an exception to cashing out early and waiving the penalty. Your divorce proceeding can become complicated by cashing out a retirement asset. You can avoid taxes and more by defining and allocating IRAs and other retirement plan assets with the help of a seasoned divorce attorney.

Cashing Out an IRA to Pay for Your Alabama Divorce

Many people consider tapping into their retirement funds if they don’t have the necessary liquid assets to pay for a divorce. You should keep this as a last resort because of the heavy penalties and costs associated with it. Taking out money from your IRA will be considered an early withdrawal if you are not 59 1/2 years or older.

The IRS will demand taxes on the amount you withdraw along with a 10% penalty. In Alabama, the law changed in 2017 to give judges full discretion regarding the division of retirement funds. You can split up retirement accounts even if the marriage lasted for a single year. You don’t need to be married for a minimum of 10 years anymore to treat the IRA as a marital asset.

If your IRA is treated as a joint asset, it may complicate asset division. You may want to work with a knowledgeable divorce attorney. The court will treat the withdrawal for covering divorce fees as a joint asset. You may end up paying more to your ex-partner, in the long run, to cover up for the early withdrawal.

Avoiding Taxes and Penalties Linked to Early Withdrawal

You will need to pay 10% percent as a penalty for early distribution and income tax on the amount withdrawn. You may be able to find a way around the taxes and penalties by transferring the money directly to your spouse before the divorce. However, it is necessary for the divorce decree to provide for the transfer of funds.

The money leaving your account should be a transfer and not treated as a distribution. IRA doesn’t require a QDRO or qualified domestic relations order for achieving penalty-free and tax-free treatment. In short, you will need to transfer the money to your ex before the divorce decree is finalized. This way the retirement account can serve its initial purpose.

Penalty Exemptions for Early Distribution

There is a short list of exemptions where the IRS allows waiving the 10% premature distribution penalty. In relation to this, you will still be responsible for paying taxes as applicable on the distributed income. You may be able to cash into the IRA without facing any penalty if the financial strain is owing to the divorce.

For instance, you can use the money to pay for medical insurance, medical bills, and college tuition. If you haven’t owned a house in the previous 2 years, you can also use up to $10,000 for purchasing a home. If you are stuck between paying for your divorce attorney and your child’s tuition fee, you can use any available cash towards the divorce expenses. You can use an IRA distribution for paying the child’s tuition fees.

Transferring the Funds to Your Spouse

There is specific information listed in most divorce agreements regarding the treatment of retirement accounts in the event of a divorce. If your divorce agreement requires the IRA or a part of it to be transferred to the ex-spouse, you should get it done immediately.

Never withdraw the amount in cash and give it to them. You won’t be able to avoid taxes and penalties on the amount. In addition, your ex-spouse will not be required to pay any taxes on the cash you give them. You can avoid this by outlining the transfer in the divorce decree. A QDRO can be helpful in transferring funds without early penalties or taxes.

Legal Assistance with Divorce and Retirement Accounts

Planning for retirement is one of the main decisions you will take in your life. There are several nuances to the division of marital assets, such as retirement benefits and accounts. You should understand the process completely before attempting to divide the assets. The period around the divorce is often emotionally charged.

Allow a competent and compassionate divorce attorney to look out for your best interests and design a way of distributing the funds with minimal financial burden. An experienced divorce attorney will follow all proper procedures to ensure the division of assets is in compliance with federal and Alabama law.

You should speak with a trusted attorney about minimizing the impact of your divorce on any IRAs and retirement accounts held.

Get Legal Representation from a Skilled Divorce Lawyer in Alabama

When you have the dedicated family law attorneys at the Smith Law Firm working on your divorce, you can rest easy knowing that you are in good hands. Our lawyers have a deep understanding of Alabama laws and can help you protect your assets and legal rights. To set up your free and confidential consultation, call our legal team today at 334-702-1744 or reach us online.