Dividing assets in a divorce is never easy. The tug-of-war of money, property and emotions can leave both sides frustrated and uncertain about their financial futures. When the time comes to untie the knot, annuities are one of the major assets that can be on the chopping block.
Couples must ask hard questions of each other (and of themselves) and make hard decisions that can have long-term implications. Does one side value the annuity more than the other? Is it worth cashing in the annuity now?
Couples also have to address non-personal but still relevant questions: Will the contract be divided or transferred into new annuities? Can they be exchanged for something of equal value? Do state laws or terms within the contract prohibit dividing the annuity?
Answering these questions takes work, but you can prepare yourself for meeting with your divorce attorney and financial advisor by knowing what factors will be considered to reach a settlement. You will want to dig into the details of your annuity: who issued it, when it matures, if there are any potential penalties for dividing it up and if you can cash it out.
State regulations dictate what couples can do with their existing annuities or structured settlements. Although many states adopted the same code of laws that govern what can – and what can’t – be done to sell or separate an annuity, laws can vary in many other states. A financial advisor or planner should know these answers. (Sometimes an experienced divorce attorney will know them, too.)
When one party purchased an annuity before the marriage and premiums were not paid during the marriage, that annuity typically remains with the original owner. Ones purchased during a marriage — especially when both parties have contributed to premiums and the annuity is a joint annuity — usually get divided.
Who Issued Your Annuity Contract?
The company that issued your annuity is a key factor in determining how your assets will be divided. Annuities may be purchased through financial planners, life insurance brokers or securities brokers. Whoever issues your annuity determines the details of the contract, which include how it can be divided up in the case of a divorce.
Each annuity contract has its specific rules about whether it can be divided up. Some issuers don’t allow annuities to be split. Others do. And still others don’t permit them to be cashed out for a lump sum.
Leaving Your Spouse with the Annuity
Depending on what other assets two people shared during their marriage, you may hold the option of having one person keep the annuity while other person keeps something else of equal value.
This can be tricky. It requires both people to have a valuation expert determine the annuity’s worth and that of the other asset, if it is not cash. If you and your soon-to-be-ex can agree, you likely will preserve the value of the annuity by avoiding certain penalties and charges.
But any discrepancy in the annuity appraisal can be difficult to overcome, and you probably will move on to another option.
Penalties, Income Tax and Other Charges
One option can be deciding as a divorced couple to take immediate payments from the annuity. This generally comes with heavy financial consequences.
People under the age of 59 ½ owe a 10-percent penalty to the Internal Revenue Service (IRS) if they pull out retirement funds ahead of schedule. The IRS also taxes these payouts as income, which can put the newly divorced in a higher tax bracket.
Another result of taking a lump-sum payout from the annuity or structured settlement issuer is that part of the annuity value drops because of surrender charges. This is a fee annuity owners pay for accessing their money early.
Changing your annuity contract by designating a new beneficiary or splitting up payments can also mean losing some benefits earned over the time you have owned the annuity. For instance, you could lose living benefits or death benefits. The extent of the loss depends on the extent of the early withdrawals.
New Surrender Period
Some annuity divisions go off without a hitch and without any added taxes or penalties. You want to pay attention as the timeline of your payments might change, even when the value stays the same.
When there is a transfer of ownership or an exchange into new annuities, the time when periodic payments are distributed can change. This is called having a new surrender period.
The previous payment schedule for may have revolved only around your spouse’s retirement date and life expectancy. If you keep the annuity, the new schedule can take into account your health and age to calculate the new payment schedule. This may limit your ability to take non-penalized withdrawals.
For those with qualified annuities – the kind of annuity purchased as part of a tax-advantaged retirement plan – you may want to get a Qualified Domestic Relations Order (QDRO). This is an official divorce-court document that describes how tax-deferred plans will be split equally in a divorce. You can use the document to divide private pensions, 401(k) plans and other retirement benefits.
The terms of the original annuity contract will get taken into consideration. Based on the QDRO and the annuity contract, the court may allow for future periodic payments to be divided up or distributed in a lump sum. You need to have to have the QDRO in place before your divorce is finalized to protect both parties.
If you have a non-qualified annuity, the issuer may require a similar type of court order like a certified divorce decree or settlement agreement before dividing up an annuity.
Annuities are complex insurance products with rules that will require even the savviest of divorce attorneys to pay thorough attention. With proper legal help and the guidance of a financial professional, you will be able to get the most from your assets and face minimal loss when making changes to your annuity contract.