When two spouses divorce, one of the key legal issues they will face is how to divide their assets amongst themselves. In California, divorcing spouses are free to reach a settlement agreement on their own (or through the help of a mediator) which is fair in light of California law, and, if they do not, the court will divide their property for them. With a financial instrument like an Individual Retirement Account (IRA) that carries tax implications, however, it is important for each spouse to understand not only the rules regarding property division but also the tax rules that will affect an IRA transfer.
Division of IRAs in California
The most important principle in property division in California is the classification between community property and separate property. Put briefly, community property includes all property that either spouse earned or acquired during the marriage, while separate property is property that either spouse had before the marriage or which was given as a gift or inheritance to them individually and not to both spouses. In a divorce, community property is split 50/50 amongst the parties while separate property is awarded to whichever spouse already owned it as such.
Thus, if a wife funded an IRA with money that she earned throughout her marriage, then that IRA will be considered community property and would be included in the amount of property to be divided equally between the spouses. But if she funded the IRA entirely prior to the marriage, or she inherited it individually, then it would be separate property that would go entirely to her.
Where the IRA is funded with a mix of separate property and community property – for example, if she funded the IRA for three years prior to the marriage and then for another seven years during the marriage in equal amounts – then the court would apportion the value of the IRA to both the community property and separate property pools based on the source of the funds. Thus, roughly 30% of the IRA in that example would be considered separate property and the other 70% would be considered community property.
Keep in mind that not every individual piece of community property must be divided 50/50, but rather the total amount of community property must be split 50/50. Thus, if a couple owned an IRA worth $15,000 and a vehicle also worth $15,000, one spouse could keep the IRA in full and the other spouse could keep the vehicle.
Tax Rules and Division of IRAs
Should an IRA be split between spouses in a divorce, however, it is important to follow specific procedures to avoid early withdrawal and tax penalties in making the partial transfer of the IRA. The IRS will allow one spouse to make a transfer of part of an IRA to another as part of a divorce without incurring tax and withdrawal penalties, but it must be done: 1) only as part of a divorce decree (and not as part of an informal division of property), and 2) only when transferring to an IRA in the other spouse’s name.
Get Help From California Family Law Attorneys in Your Divorce
The family law attorneys at The Law Offices of Omar Gastelum and Associates, PLC, with offices in Los Angeles and Newport Beach, represent individuals and families in all aspects of family law. For help with any family law matter, contact our office today to schedule a consultation.