An IRA Is Divided Differently Than a 401(k)
Individual Retirement Accounts (IRAs) are among the most commonly divided assets in a Texas divorce. Although an IRA is a retirement account like a 401(k), the legal procedure for transferring the account is different.

A 401(k) generally requires a Qualified Domestic Relations Order (QDRO) before the plan administrator may divide the account. An IRA, however, typically does not require a QDRO. Instead, the financial institution holding the IRA usually requires its own transfer paperwork together with the Final Decree of Divorce or other documentation sufficient to establish that the transfer is incident to divorce.

Every financial institution has its own procedures, so it is important to determine those requirements early in the divorce process.

Traditional IRAs and Roth IRAs Are Taxed Differently
Although Traditional IRAs and Roth IRAs are both retirement accounts, they do not have the same tax characteristics.

A Traditional IRA is generally funded with pre-tax dollars or tax-deductible contributions. As a result, distributions taken during retirement are generally taxable as ordinary income.

A Roth IRA, on the other hand, is generally funded with after-tax dollars. If the statutory requirements are satisfied, qualified withdrawals from a Roth IRA are generally received free of federal income tax.

This distinction is important during a property division. Two retirement accounts with identical account balances may not have the same after-tax value because of their different tax treatment. When negotiating a divorce settlement, attorneys often consider the tax characteristics of retirement assets rather than simply comparing account balances.

Because every taxpayer’s situation is different, parties should consult a Certified Public Accountant (CPA) or tax professional regarding the tax consequences of any proposed property division.

Only the Community Property Portion Is Subject to Division
Texas is a community property state. Retirement contributions made during the marriage are generally presumed to be community property, while retirement assets owned before marriage are generally separate property. See Tex. Fam. Code §§ 3.002, 3.003, 3.007, and 7.001.

If an IRA existed before the marriage, the account may contain both separate property and community property interests. Likewise, investment growth attributable to the separate property portion may, under appropriate circumstances, remain separate property.

As a result, it is important to determine not only the current value of the account but also when the contributions were made and how the account has changed over time.

Tracing May Be Necessary
If an IRA was opened before marriage or contains funds that originated from separate property, a tracing analysis may be required.

Tracing is the process of identifying the separate property portion of an asset and distinguishing it from community property accumulated during the marriage. Depending on the history of the account, tracing may require historical account statements, rollover documentation, contribution records, brokerage confirmations, and other financial records.

In more complicated cases, we work with forensic accountants and other qualified financial experts to perform the tracing analysis and accurately identify the community and separate property interests.

If you owned an IRA before marriage, you should inform your attorney immediately so that historical records can be obtained before they become more difficult to locate.

Individual Investments Matter
Many IRAs are not invested in a single mutual fund or cash equivalent. Instead, they may contain dozens—or even hundreds—of individual investments, including publicly traded stocks, exchange-traded funds (ETFs), mutual funds, bonds, certificates of deposit, and other securities.

When dividing an IRA, it is often important to consider the individual stock lots and investment positions, rather than looking only at the total account value.

For example, one spouse may prefer to receive shares of a particular stock, while another may prefer mutual funds or cash. Some investments may have appreciated significantly, while others may have unrealized losses. Certain securities may also have different tax characteristics that should be considered during settlement negotiations.

Carefully accounting for the individual holdings often allows the parties to reach a more equitable and practical property division while avoiding unnecessary liquidation of investments.

An IRA Is Not the Same as Cash
One of the most common mistakes during settlement negotiations is treating an IRA as though it were a bank account.

Although an IRA statement may show a balance of $100,000, that does not necessarily mean the account has the same economic value as $100,000 in cash.

Traditional IRAs generally contain pre-tax retirement assets. Future distributions may be subject to federal income taxes, and depending upon the circumstances, early withdrawals may also result in additional tax consequences or penalties. Accordingly, retirement assets often have a different after-tax value than immediately available cash.

For this reason, when dividing a marital estate, retirement accounts should be carefully evaluated alongside cash accounts, brokerage accounts, and other assets. A spreadsheet that simply assigns equal dollar values to every asset may unintentionally create an unequal property division if the tax characteristics of those assets are ignored.

An experienced divorce attorney, working together with a CPA or financial expert when appropriate, can help evaluate these differences during settlement negotiations.

Dividing an IRA Generally Does Not Trigger Immediate Taxes
Many clients worry that transferring part of an IRA to a former spouse will immediately result in income taxes.

When an IRA is properly transferred incident to divorce in accordance with federal tax law and the financial institution’s procedures, the transfer itself generally is not a taxable event. Taxes are generally deferred until retirement funds are later withdrawn from the account.

However, if either party elects to take a cash distribution rather than maintaining the funds in a qualified retirement account, income taxes—and in some cases additional penalties—may apply.

Because tax consequences depend upon each person’s circumstances, every party should consult a Certified Public Accountant (CPA) or tax advisor before making decisions regarding retirement assets.

Fergus & Tomanka Can Help Protect Your Retirement Assets
Retirement accounts are often among the most valuable assets accumulated during a marriage. Properly dividing an IRA requires more than obtaining a current account balance. The characterization of community and separate property, tracing pre-marital contributions, evaluating the tax consequences of Traditional and Roth IRAs, accounting for individual investment holdings, and preparing the documentation required by the financial institution all require careful planning.

At Fergus & Tomanka, we regularly represent clients in divorces involving IRAs, 401(k)s, TSPs, TRS, ERS, FERS, military retirement, brokerage accounts, and other complex financial assets. We work with qualified forensic accountants and tax professionals when appropriate to help ensure that retirement assets are accurately characterized, properly valued, and divided in accordance with Texas law.