With a volatile stock market and pitifully low-interest rates plaguing the economy for more than a decade now, owning an annuity – particularly a fixed or fixed indexed product – can be part of an overall strategy to grow assets safely, as well as to ensure that retirement income will continue for as long as you need it to.
But if you own an annuity with your spouse, what happens to the annuity if you opt to divorce?
Annuities and Divorce
Every year, millions of dollars in wealth across the United States are unnecessarily destroyed when divorces lead to annuity contracts being divided as a part of the settlement – and both of the spouses can be impacted equally. But it doesn’t have to be that way.
There is actually nothing in the IRS tax code that dictates how an annuity should be divided when a couple gets divorced. However, some of the more common options usually include:
- Withdrawing the money from the annuity (provided it isn’t in the income payout stage yet). This, however, can head to the payment of taxes on the amount that is considered gain.
- Dividing up the income stream between the two ex-spouses.
- Using money from the original annuity to purchase another one. In this case, if the money that is taken from the initial annuity is used to buy another one from the same insurance company, then no taxes are due. The same holds true if money is transferred directly from one annuity to the other.
In any of these situations, though, it may still be possible that you will incur an early withdrawal penalty if the original annuity is still within its surrender period and/or be responsible for the payment of taxes.
In addition, if the annuity included any “living benefits,” such as penalty-free withdrawal waivers for terminal illness and/or long-term care needs, these could be negatively affected, too.
Retirement Plans, Divorce, and Annuities
If an annuity is held in a retirement plan, it is possible that a document referred to as a qualified domestic relations order, or QDRO may be used to help with an equitable settlement. QDROs are legal documents that are oftentimes used with divorce agreements.
These documents recognize that a spouse or former spouse, as well as possibly a child(ren) and/or other dependent(s) is entitled to receive a pre-defined portion of an account holder’s retirement plan assets. This can include any annuities.
As a part of the Employee Retirement Income Security Act, or ERISA, qualified domestic relations orders are required for compliance in terms of offering protection for both the participant in the retirement plan, as well as his or her beneficiary(ies).
QDROs are generally handled after a divorce has been finalized. There are some items to keep in mind with regard to annuities that are involved in a divorce. These include the following:
- After a distribution from an annuity has been made, the former spouse (i.e., the recipient of the funds) will then be responsible for any taxes that are – and that will be – due.
- Rather than taking funds directly from an annuity that is handled through a QDRO as part of a divorce settlement, the recipient of the annuity money may opt to roll the funds over to his or her own retirement account.
Because there can be so many issues to cover with regard to divorce and annuities, it is highly recommended that you work with an annuity specialist who can guide you through the process. Otherwise, without a proper strategy in place, you and/or your former spouse could end up having to pay a significant amount of taxes.
Still Have Questions About Annuities?
Even with all of the benefits that they offer, annuities can be somewhat complicated financial vehicles. So, if you have an annuity – or you are considering the purchase of one – it can help to talk with a specialist in this area before you make a long-term commitment. That way, you’ll have a better idea of what you can anticipate. You can also narrow down the annuity and the insurance company that may be best for you and your needs going forward.
At Annuity Gator, our mission is to educate consumers on how annuities work, and where they may (or may not) fit in an overall financial or retirement plan. With that in mind, if you have any questions about annuities, feel free to set up a time to chat with an annuity specialist by calling (888) 440-2468 or by sending us an email to our secure online contact form. We look forward to helping you learn more about these flexible tools that can be used before and during retirement.