Annuities & Divorce

Splitting marital property is an unavoidable task that accompanies divorce. For some, annuities make up a significant portion of their future retirement earnings.

Dividing financial assets can often be a complicated process, with your financial options dictated by potential tax implications. You should seek to understand the long-term consequences of changing your policy as you plan for your new life.

Page Contents

    Dividing Up Assets

    Every year, millions of Americans go through a divorce, meaning there’s always a large number of people who scramble to divide up assets. In fact, the American Psychological Association estimates that 40 to 50 percent of couples in the United States divorce.

    When they do, it starts the official process of division. Like it or not, couples that break apart legally have to figure out how to share virtually everything in their lives: kids, money, houses and cars and retirement and investment assets.

    Dividing Assets in a Divorce

    Some things divide up evenly into two. Others, not so much. Some of these decisions involve a lot of personal attachment and sentiment, while others – like annuities – involve a lot of financial calculation.

    Even divorce attorneys may not appreciate the difficulty of dividing up an annuity because of the way some of them are designed and because of the complicated tax implications of making a change to the annuity policy itself. The ramifications depend on the type of divorce that you get, the type of annuity you have and the various taxes and fees attached to your policy. Annuities come in many varieties, and many companies issue them. Each has its own set of restrictions about couples can adjust the investment if they get divorced.

    Type of Divorce Settlement

    There’s more than one legal way to get divorced, and often both sides have their say in how they want it to happen. Even so, state laws and the amount of money involved dictate some of the options.

    Options to Consider:
    Summary DivorceThis involves shorter marriages, fewer assets (property), less debt, no children and does not require lawyer.
    Uncontested DivorceThis involves mutually agreed upon terms and cooperative behavior. There is not a formal trial, lawyer and often no court appearance is required.
    Default DivorceIt can be granted by the court when one spouse is not participating.
    Fault & No-Fault DivorceThese involve irreconcilable differences, irremediable breakdown of a marriage.
    Mediated DivorceCouples agree to engage a neutral third party to mediate disputes and assets.
    Collaborative DivorceLawyers on both sides work with clients and each other to reach settlement.
    ArbitrationA private judge is hired to help make decisions.
    Contested DivorceThe judge must decide terms. It often involves custody and child support, property division, debt allocation, alimony, temporary spousal support.

    Gray Divorce

    Getting divorced later in life presents a unique set of problems. Some people above the age of 40 report that a divorce is more devastating than losing a job, equal to going through a major illness, and only slightly less devastating than the death of a spouse. One out of 20 divorced Americans are 65 or older – victims of so-called “gray divorce.”

    In gray divorce, the division of assets takes the forefront rather than child custody, as any children from the marriage are no longer minors.

    Special considerations for divorcing later in life:

    • Carefully analyze all your retirement accounts. Retirement funds, like annuities, are almost always split evenly – even if one spouse is considered at-fault for the divorce.
    • Ask your attorney about having your spouse provide health care coverage as part of the settlement, if necessary. Getting health insurance in your 60s can be particularly challenging and Medicare doesn’t kick in until age 65.
    • Review your rights under Social Security before the divorce is final. If you’ve been married for more than 10 years and you’re above the age of 62, you can collect Social Security on your former spouse without reducing his or her benefits.
    • Discuss tax concerns with your accountant. Filing as single means paying more in taxes.

    Annuities as Marital Property

    Annuities considered marital property must meet state law and insurers’ rules about divorce. Because you can pay for some of them over time with periodic premiums and because there are a variety of ways to recoup the investment – with a lump sum, with several lump sums or with a long string of small payments – dividing them up can get complicated. Time changes how much payments are worth, and the value doesn’t necessarily transfer to a fixed dollar amount.

    A court may not consider certain annuities as marital property if they were purchased prior to – and no one made premiums after – the marriage. For the most part, these annuities remain with their original owner. In that case, splitting them is unnecessary.

    If both parties paid premiums while married, the annuity is typically split. Some annuities are owned jointly between spouses, while others are individually owned. You can transfer in part or in whole an individually owned annuity.

    During a divorce, a couple could change some or all of these elements. The company that issued the investment dictates what can get changed. Regulations are in the original investment contract. Some contracts have more restrictive language than others about what can get change and what can get divided. Usually the company requires notification from both spouses or demands papers from the divorce decree to make any changes.

    Three elements come into play when it comes to dividing annuities:

    • The current annuity owner (the person that paid premiums)
    • Person receiving payments (could be the same person or a spouse)
    • Beneficiaries (who is scheduled to receive remaining payments or death benefits)

    Taxes & Fees

    Couples can save money by trading other assets rather than splitting annuities. However, tax laws offer protections for minimizing liability.

    The IRS allows certain exemptions for owner transfers related to divorce. Couples moving the annuity from one spouse to another don’t face added tax liability for the transfer. In other words, the IRS treats divorce as a non-taxable event.

    The tax-free portion of the annuity remains tax-free. Either party accepting future payments still owes income tax on distributions.

    If one spouse accepts an early distribution from an annuity as part of a divorce settlement, then the IRS requires income tax on earnings and charges an early withdrawal penalty. When the owner of a policy changes the asset to an entirely different, new annuity, known as a 1035 exchange, they do not owe added taxes. For the 1035 exemption to apply, the transfer must meet certain stipulations.

    Notes on Transfer or Split Scenarios:

    • Transferring or splitting an annuity may initiate a new surrender period, as defined by the insurance company, which means the time table for higher interest on withdrawals is reset.
    • Individual annuity contracts put limitations on what transfers in the case of a divorce. Most contracts do not allow transfers of living benefits or added riders.

    Qualified Annuities

    Couples with annuities held in qualified retirement plans (like a 401(k) or IRA) need a Qualified Domestic Relations Order (QDRO) to protect tax exemption. A court issues the QDRO, and it often divides 50% of retirement assets.

    The court takes the terms of the original annuity contract into consideration. Based on the QDRO and the annuity contract, the court may allow a couple to divide future periodic payments or distribute the annuity in a lump sum. You need to have to have the QDRO in place before your divorce is finalized to protect both parties.

    The court requires that insurers comply with orders for splitting the annuity. A state court judgment, decree or order, or approval of property settlement agreement can define rules for dividing the asset.

    Surrendering or Selling Payments

    Couples can resolve annuity disputes related to divorce by surrendering or selling payments to convert the annuity from a policy to cash.

    Annuity owners can surrender their policy through the insurance company issuing it. You will owe surrender fees, determined by factors such as how long the policy has been in place, whether distributions started and the amount of distributions. and other annuity buyers offer competitive rates for future payments in exchange for a lump sum of cash.

    While you lose a portion of the asset’s value when selling or surrendering, dividing a simple cash total can be easier than having an actuary determine value, trying to split the policy and changing your contract.

    Divorce Attorneys and Financial Advisors

    Speak with a divorce attorney and financial advisor to evaluate your options and look at financial repercussions of changing annuity contracts.

    Insurance companies create complex contracts with rules dictating how the policy may or may not change. Even the savviest of divorce attorneys must pay thorough attention when evaluating the consequences of dividing this asset.

    Get the most from your assets and face minimal losses when making changes to your annuity contract by seeking proper legal help and the guidance of a financial professional.

    Page Sources

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