Your Mediated Settlement Agreement (MSA) outlines how financial accounts will be divided between you and your soon-to-be ex-spouse. Completing these transfers promptly may be especially important when one spouse continues to draw from joint resources. The challenge is to divide accounts efficiently while avoiding unnecessary taxes, fees, or costly financial mistakes.
Consider working with a financial professional who has experience in divorce-related financial planning, such as a Certified Divorce Financial Analyst® (CDFA®) who also provides wealth management services.
Taxable Brokerage Accounts
These accounts are sometimes referred to as taxable investment accounts. If an account is not a Traditional IRA or Roth IRA, it is likely a taxable brokerage account. Taxable brokerage accounts hold investments such as stocks, ETFs, mutual funds, bonds, and cash.
When handled properly, transferring investments (“journaling” positions) between spouses incident to divorce generally does not create a taxable event. In many cases, taxable brokerage accounts can be divided based on the terms of the Mediated Settlement Agreement and cooperation between the spouses before there is a final divorce decree.
Each investment inside a taxable brokerage account, often referred to as “positions,” can be sold to generate cash when needed. However, selling investments may trigger capital gains taxes.
Tax Consequences When Investments Held in a Taxable Brokerage Account Are Sold
Taxes generally apply to the gain, which is the difference between the purchase price (known as the cost basis) and the sale price. The lower the cost basis relative to the current value, the larger the potential taxable gain.
Long-term capital gains are typically taxed at preferential rates of 15% or 20%. The applicable rate depends on the taxpayer’s income and other factors. Because tax laws can change and individual circumstances vary, consult your tax professional regarding your specific situation.
Dividing an Account by Tax Lot
Each time an investment is made, a separate “tax lot” is created. The tax lot records the purchase date, purchase price, and other details necessary to determine future gains or losses.
If both spouses will receive identical percentages of the same investments, dividing the account by tax lot can help ensure that each spouse receives a proportionate share of the cost basis. Alternatively, spouses may negotiate a division that allocates higher-cost-basis investments to one party and lower-cost-basis investments to the other. Because these differences can have significant future tax consequences, professional guidance is often valuable.
Additional Considerations
Before dividing a taxable brokerage account, consider the following:
- Margin Loans or Securities-Based Lines of Credit: Investors may borrow against a brokerage account. Any outstanding loan reduces the account’s net value because assets may need to be liquidated to repay the debt.
- Private Investments: Private equity, private credit, hedge funds, limited partnerships, and other alternative investments may have transfer restrictions or special requirements that affect division in divorce.
Individual Retirement Accounts (IRAs)
IRAs differ from 401(k) plans. A 401(k) is an employer-sponsored retirement plan maintained through an employee’s workplace. IRAs are individual retirement accounts owned by a single individual.
Many IRAs originate when a former employee leaves a company and “rolls” cash and/or investment positions from a 401(k) into an IRA.
Traditional IRAs and Roth IRAs
Traditional IRAs generally contain pre-tax assets. Withdrawals are typically taxed as ordinary income, and penalties may apply to distributions taken before age 59½ unless an exception applies.
Roth IRAs are funded with after-tax dollars. Qualified withdrawals are generally tax-free after age 59½, provided IRS requirements have been satisfied. However, certain withdrawals may still be taxable or subject to penalties.
Consult your CPA or tax advisor before taking distributions from any retirement account.
Dividing an IRA in Divorce
IRAs are not jointly owned. If you are awarded all or part of your spouse’s IRA, you should establish an IRA of the same type in your own name and arrange for a direct transfer from your spouse’s account to yours.
For IRAs – Wait Until the Divorce Is Final
In most cases, IRA transfers should not occur until there is a signed Final Decree of Divorce or other qualifying divorce instrument.
The IRA custodian (Schwab, Fidelity, Vanguard, or another institution) will typically require documentation showing that the transfer is incident to divorce. If an IRA transfer is not completed correctly as a direct transfer incident to divorce, the transaction could be treated as a taxable distribution, potentially resulting in unexpected taxes and penalties.
Additional Considerations
- Loans: Unlike 401(k) plans, IRAs generally do not permit participant loans.
- Private Investments: As with brokerage accounts, privately held investments inside an IRA may require additional planning and documentation before they can be divided.
- Sales of investments inside IRA accounts are not taxed. Taxes only occur if there is a withdrawal. Thus, rebalancing to increase or decrease the account’s investment risk is possible without taxes.
Final Thoughts
The division of investment and retirement accounts during divorce can have long-lasting tax and financial consequences. Working with a Certified Financial Planner™ professional who has divorce expertise or a Certified Divorce Financial Analyst® with wealth management experience can help ensure transfers are completed correctly and in accordance with your divorce decree, while minimizing avoidable taxes and administrative complications.
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