Can an inherited individual retirement account be split in a divorce? No one knows for sure, but it's already happening. This is a new phenomenon, and it may signal a developing trend in future divorce agreements, especially in light of the new alimony rules that go into effect in 2019. IRAs may play a bigger role in divorce settlements, with the pretax funds being used to make up for the lost alimony deduction. There is no question that IRAs have become a major asset and more of a bargaining chip in divorce. But now we're seeing inherited IRAs being split in divorce. Is that allowable? Neither the tax code nor the regulations ever considered this prospect, so there are no official rulings on this — no IRS guidance, no private letter rulings, not even any court cases that tell us definitively if inherited IRAs can be split tax-free in a divorce the way that an owned IRA can be split. But here's the thing. It's being done anyway. Courts have allowed the inherited IRA to be split up in divorce (with a court order pursuant to a divorce agreement), and the IRA custodians are accepting the transfers of the inherited IRA funds, probably because they don't want to defy a court order. The account retains its inherited status and the required minimum distribution schedule remains unchanged. The decedent's name stays on the account with only the name of the new beneficiary (the ex-spouse) being added. This is happening when one spouse may have inherited a large IRA and wants to use part of that to satisfy the agreed property split. This arrangement should be part of the divorce agreement, including confirmation that each spouse will be responsible for future RMDs based on the percentage they keep. (More: Divorce 2019: How to use IRAs and 401(k)s to ease future alimony planning)
Besides the ability to split an inherited IRA in divorce, there is a second issue here. Are inherited IRAs even part of the marital pot? Generally separate property is that which was acquired before the marriage. It also includes gifts and inherited property (even if received during the marriage). However, separate property can lose its status if it is commingled with marital property. For example, a husband inherits his mother's home, but he retitles it in joint name with his wife. Other than these exceptions, property acquired during the marriage is usually marital property. Even a retirement account, which can only be in an individual name (there is no such thing as a joint IRA) is marital property if funds are contributed to it from earnings during the marriage. But inherited IRAs are a different story. Inherited IRAs cannot be owned jointly and new contributions cannot be made to the account, as could be the case with an inherited bank account. That seems like a clear case of separate property. But state law prevails here and not all states agree, so you have to know how your state law treats inherited IRAs. A local matrimonial attorney should know this and should be consulted here. That goes as well for seeing whether any appreciation during the marriage on the inherited IRA funds might be marital property. That could depend on whether the account management was active or passive. Active management could be present when the non-beneficiary spouse helped manage and grow the account. Even if the inherited IRA is deemed separate property, it can still be used to satisfy the property split, the same as any other separate property funds. For example, the wife agrees to give the husband $100,000 to keep certain other property. If she has an IRA she inherited from her brother, she can use that account to make the deal. The wife could take the funds out of her inherited IRA, but that would be a taxable distribution to her. In order to avoid any taxation, the split of the inherited IRA must follow the same rules as the transfer of owned IRA funds. The split must be in accordance with the divorce decree and the transfer must be done as a direct trustee-to-trustee transfer. (More: Divorce reduces retirement readiness) Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group. He can be reached at irahelp.com.
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