Business & Finance Personal Finance

Who Pays the Taxes When Early Annuity Distribution Is Part of a Divorce Settlement?

    Early Distribution

    • Taking an early distribution from a tax-deferred annuity is not recommended in divorce scenarios. If you own the annuity, you are responsible for both the income taxes and the early distribution penalties owed on the withdrawal. All pre-tax dollars taken out of the annuity are added to your income. Anything taken out before you reach age 59 1/2 results in a 10 percent penalty tacked on by the Internal Revenue Service.

    A Better Option

    • When going through a divorce, consult with your family court attorney or a tax adviser before distributing assets. If you and your former wife agree that the assets need to be split, then perform a "Qualified Domestic Relations Order." The QDRO is a court order specifically designated to split tax-deferred funds without creating a taxable distribution. The QDRO is the only means of moving assets from your annuity and Social Security number into a new account under your ex's Social Security number.

    Advantages of the QDRO

    • When you take a partial distribution and give it to your ex as part of the divorce settlement, more issues than the tax bill are involved. Your cannot take the amount you give and place it into another annuity. The ability to grow those assets under the tax-deferred umbrella is lost forever. Even when innocently done, a judge might see this move as vindictive to an ex-spouse. The QDRO preserves the deferred growth status for all parties with no tax bill. Once the split is complete, each party is responsible for all distributions, contributions and taxes associated with her own account.

    The Process

    • The process for a QDRO is longer than taking a distribution and going different ways. Family courts have a calculator that determines how much is owed to an ex in a divorce settlement. The annuity is part of the marital estate and may be equally split or divided by another means based on negotiations. Once the amount is determined, the former wife must open a rollover account first. The account number, annuity custodian and all contact information is required as part of the QDRO. That information must be incorporated into the court order with the existing annuity information and entered into the family court system and signed off by the judge. Once approved by the courts, copies of the QDRO are attached with rollover and transfer forms for the annuity custodians to properly transfer.

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