Dividing a Variable Annuity in a Divorce Settlement
Divorce settlements can be both simple and complex arrangements, depending on the distinct circumstances of the relationship. Financial matters to be resolved in a settlement may include the division of investments and savings. A variable annuity, one type of investment product, can be divided several ways as part of a divorce settlement. However, taxes need to be considered when dividing a variable annuity to make the best arrangement for both parties.
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Qualified Domestic Relations Order
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According to SmartMoney, dividing financial assets, such as those within a variable annuity contract, should only be done in a divorce settlement with a proper qualified domestic relations order. The Internal Revenue Service defines a QDRO, in part, as a legal order pertaining to the payment of marital property rights.
Tax Implications
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In ordinary circumstances, when the structure of a variable annuity contract is modified, transferring assets in the account is treated as a nonperiodic distribution and therefore subject to federal income tax. According to the IRS, the rule of treating annuity transfers as distributions does not apply when it is part of a divorce settlement. However, this exclusion does not pertain to future tax obligations when regular distributions are later received. With a proper QDRO in place, the ex-spouse is responsible for income taxes on future distributions received from the variable annuity. SmartMoney warns that should a proper qualified domestic relations order not be in place, the original owner of the variable annuity could be held liable for all federal income taxes due on forthcoming distributions.
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Transfer of Assets
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The company that manages the annuity may offer a choice of methods for dividing the variable annuity. For example, one method is a withdrawal of all or part of the assets in the account with a direct distribution to the ex-spouse. A second choice that may be offered is to transfer the amount awarded directly, whether a specific dollar amount or a percentage of the total contract, to the ex-spouse via a transfer to an individual retirement account designated by the ex-spouse.
New Contracts
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A third option offered could be to split the annuity into two contracts with a specified dollar amount or percentage of the current value being designated as going to the ex-spouse. In this instance, a new contract is issued for the ex-spouse. If the variable annuity was jointly owned prior to the divorce settlement, two new contracts may be issued during the process of dividing the assets in the account. A fourth choice, that does not split the variable annuity but may be necessary in some divorce settlements, is to transfer ownership of the contract in whole to the ex-spouse, in which case a new contract goes into effect. When more than one annuity contract is owned this may be a means of dividing the total assets of the marital estate.
Management Requirements
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The agency or financial institution that manages the variable annuity requires the account holder to authorize the split or transfer between ex-spouses. In addition, the firm in charge may ask for a certified copy of the divorce decree and settlement terms. Larger firms may request a proper QDRO to divide the variable annuity. Generally, legal documents clearly outlining the percentage or dollar amount awarded to the ex-spouse is required to divide the variable annuity.
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References
- Internal Revenue Service: Publication 575 (2010) Pension and Annuity
- Legal Ace: Divorce and Retirement
- Merrill Lynch Wealth Management: 5 Things That Could Derail Your Retirement
- RiverSource: Annuity Divorce Form
- SmartMoney: Splitting the Retirement Accounts
- U.S. Department of Labor: QDROs, The Division of Retirement Benefits Through Qualified Domestic Relations Orders
