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Can an IRA Be Cashed Out During a Divorce?

Can an IRA Be Cashed Out During a Divorce

Your Individual Retirement Account, shortened to IRA, is a crucial investment tool that allows you to save for retirement while benefiting from various tax benefits. These retirement funds are highly regulated, so withdrawing or otherwise altering your funds could lead to significant tax penalties. If you are considering cashing out your IRA as part of your divorce, learn more about potential consequences and what to expect.

With the right legal team by your side during your divorce, you can confidently make this and other decisions. Call John H. Ruby & Associates at 502-895-2626 to set up a consultation now.

Reasons to Cash Out Your IRA

There are several reasons you may be thinking about cashing out your IRA. First off, divorce can be pricey—you may have gone from supporting one household to supporting two, or from supporting your household with two incomes to doing so on just one. If your ex-partner is dragging out the divorce and racking up your legal fees, you may need some extra cash flow. You may need to split your IRA in order to divide it as an asset. These reasons leave you with very different options and outcomes.

Legal Considerations When Cashing Out an IRA

If you want to cash out your IRA because you simply do not have enough liquid funds to make ends meet while you divorce, know that you’ll likely get hit with some painful financial penalties. The IRS only allows a handful of reasons to withdraw from your IRA early. If you withdraw for any other reason, you have to pay a 10% penalty—plus taxes on the withdrawn amount. If you withdraw for one of the approved reasons, you forgo the 10% penalty but must still pay taxes.

It’s also important to note that your IRA will likely be considered marital property. Kentucky is an equitable distribution state, which means that marital assets are divided in a way that is fair to both parties. You’ll still owe your spouse their share of your IRA if you tap into the account for short-term relief from your cash shortage. 

Let’s say you withdraw $20,000 from your IRA to cover bills and other expenses. You pay approximately $4,000 in taxes, plus a $2,000 penalty, leaving you with $14,000. The original $20,000 is still considered marital property, even though it’s no longer there. When assets are split up, let’s assume a 50/50 split. You’ll owe your ex $10,000. This may give you a short-term solution to your financial situation but cause even more issues when your divorce is finalized.

What to Expect If You Decide to Cash Out Your IRA

If you cash out your IRA in order to cover other expenses during your divorce, you should expect to lose the 10% penalty plus taxes on the withdrawn amount. It’s very different, though, if you withdraw as part of your divorce settlement.

Some couples decide that splitting up the IRA is the easiest way to divide this asset. Should you go this route, you’ll want a QDRO that meets local laws and IRS requirements. The QDRO allows you to withdraw these funds without penalty as long as the withdrawal is part of the divorce decree.

The tax consequences vary. If the person receiving the funds rolls it over into another IRA within 60 days, there will likely be no tax issues. If they simply keep the withdrawn amount, it will be considered taxable income.

Financial Alternatives

There may be other solutions available to you. If you’re interested in a withdrawal so you can make ends meet during the divorce process, look into credit cards, loans from loved ones, or other resources. Even if you have to pay interest on the balance, it will still likely end up being far less than you’d lose in an IRA withdrawal.

If the withdrawal is part of your divorce settlement, consider other ways to divide the property. For example, if your spouse is owed $50,000 from your IRA, you might instead give them $50,000 more from the joint savings account, increase the amount of money they get from the sale of your home, or otherwise allow for a $50,000 increase in other assets. This would allow you to keep your IRA and avoid the complications that come with a transfer.

Confused About Your Divorce Options? Contact John H. Ruby & Associates

Find out how the team at John H. Ruby & Associates can help you navigate your divorce. Schedule a consultation now by calling us at 502-373-8044 or connecting with us online.