Divorce and annuity ownership changes

Rule

When an annuity contract transfers from one individual to another, the transferred amount is treated as a distribution. The original owner is taxed on any tax-deferred gain and possibly subject to a 10% penalty. But this doesn’t usually apply when annuity contracts transfer between spouses or former spouses.

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Transfers between former spouses are exempt if the transfer is:

1. related to the cessation of marriage (e.g. specified in the divorce or separation agreement), or
2. occurs within one year after the date that the marriage legally ends.

Special rules apply for transactions from employer-sponsored plans that are a result of divorce.

 
What else should I know?

Before finalizing the divorce agreement, consider how full or partial transfers or withdrawals will affect the annuity contract. Even if the transaction isn’t taxable, it may adversely affect the contract features.

If either spouse distributes a portion of their contract, that distribution will be taxable. A 10% penalty will also apply if no penalty exemption is available. Special rules apply for distributions from employer-sponsored plans that are a result of divorce.

Take special care with contracts receiving a Series of Substantially Equal Periodic Payments (SSEPP). SSEPPs face additional taxes and penalties if they’re modified within 5 years, or before the owner turns 59 ½.  The IRS has privately ruled that splitting a contract because of divorce didn’t result in a modification of the SSEPP as long as payments from the accounts didn’t substantially change following the divorce. But the IRS has yet to provide authoritative guidance on this topic.

 ¹ A similar exclusion from income applies to transfers of IRAs under a divorce or separation agreement, but it is not explicitly clear that the one-year safe harbor applies to IRA transactions.  Clients may want to ensure the divorce or separation agreement specifies the transfer.

The subject matter in this communication is provided with the understanding that Principal® is not rendering legal, accounting, or tax advice. Clients should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

For financial professional use only. Not for distribution to the public.

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