Divorcing couples are wise to move forward carefully when it comes to the division of assets. This means more than just looking at the current value of assets before agreeing to a split. It also means looking at both the immediate and potential for future tax ramifications before finalizing any asset division agreement.
What types of assets can result in tax ramifications?
Although the transfer of tangible property, like real estate, generally does not result in immediate tax obligations it can lead to future tax bills. As such, it is a good idea to have a clear plan for the asset before deciding to claim it during divorce. If the plan is to sell the asset in the near future, it may be best to sell it or address the sale and tax implications (think capital gains) during the divorce.
Another form of property that can trigger tax obligations during divorce are retirement assets.
How does divorce impact retirement assets?
Those who have some financial acumen likely set up retirement assets to accumulate into a sizeable sum at the time of distribution. These retirement assets are marital property subject to division during divorce. It is not uncommon for this process to lead to disagreement. It can help for those going through the process to have a better understanding of how the court makes its determination.
The court must determine the value of the asset. When valuing a pension, like one with the Indiana Public Retirement System (INPRS), Indiana state law generally requires the court determine the evidence needed to establish the value of the benefit, the date used to assign the dollar value, and the amount of the benefit that was the result of contributions after the final separation date. The court will then use this information to come up with an estimated value of the retirement asset.
Next, the court will look to the best way to divide or distribute pension benefits. Two common methods include an immediate offset or deferred distribution. The immediate offset method involves the court providing the non-owning spouse with their share of benefits in an immediate lump sum. The court could order this payment as a cash award, if available in the marital estate, or in the form of property equal to the value due. Under the deferred distribution method, the court determines the non-owning spouse’s future benefit and orders payment at the time the owning spouse begins to receive the benefits from the administrator. When the retirement asset cannot be separated by a court order such as a Qualified Domestic Relations Order (QDRO), the court may order the beneficiary of the retirement account to provide a portion of the monthly benefit to their ex-spouse.
Courts should also take the tax consequences of the distribution into account. When it comes to retirement benefits like a pension, where taxes are generally due at the time the owner receives benefits in the form of income tax, these consequences are often conjecture — an educated guess of the likely tax rate at the time the beneficiary receives payment. Although it is not possible to get an exact estimation, it is important to use experts in the field to get a well researched guess as to the tax rate at the likely time of distribution. It is also important to consider having life insurance on the life of the spouse receiving the pension benefit owned by the non-owning spouse of the benefit, as often the pension will cease at the death of the owning spouse.
This is a complicated process. It is important to make sure you understand the full impact of any proposal to mitigate the risk of surprises after the divorce is finalized.
