What Happens to an Annuity During a Divorce?

Getting a divorce is an emotionally trying time. There are many ways to divide annuity products during a divorce, including liquidating the contract or transferring funds to a new contract.

Annuities can be complicated products, especially when deciding how to divide the value of the annuity between two parties. The division of this unique asset during a divorce is contingent upon the needs of each person and the negotiated split of the annuity assets. Since annuities can be an important part of each party’s retirement plan, these negotiations are critical and the nuances of how to split the assets are very important.

Some primary issues to be discussed during the negotiations are tax consequences, potential surrender charges and other penalties, and IRS tax exemptions for divorces.

What Happens to an Annuity in a Divorce?

Working through financial issues like property division during a divorce is not easy. When dividing assets, it is wise to have a careful, methodical mindset. While this can be difficult during an emotionally-charged time, there are experts who can help you put together a plan so that the annuity assets are divided equitably.

If your annuity assets are “qualified,” meaning the proceeds have not yet been taxed, they may be subject to a qualified domestic relations order or QDRO. A QDRO is a court order issued as part of a divorce decree that helps direct how the divorcing couple can split the funds held in a qualified annuity. This order also applies to accounts like pension plans, 401ks, and other qualified retirement assets.

If the owner of an annuity purchased it before being married, the annuity might not be subject to the division of property. However, if you purchased your annuity during your marriage, it may likely be included in the property division. That may mean a contract split or surrendering of the annuity by you or your spouse, depending on other conditions.

Seeking advice on the dissolution of an annuity asset from a divorce attorney may not be a good idea unless they also have an understanding of tax or insurance contract law. Hiring a separate tax attorney or a divorce financial advisor with experience in insurance products might be a good idea.

That’s because financial factors such as cost basis, living benefits, present and future values, potential tax liability, and death benefits of the contract all come into play. This expert review and analysis can help provide details of how an annuity can be equitably split between parties.

Whether an annuity is still accumulating funds (a deferred annuity) or has already begun making payouts (annuitized annuities) will also be a factor in how the account value of these annuities is split between divorcing parties. You can generally work with your insurance company to discuss how the annuity can be equitably split.

How Annuities May be Divided After a Divorce

Methods for dividing the annuity after divorce depends on a few factors, including whether the annuity has begun paying a stream of income or continuing to earn deferred interest.

For an annuity that has already begun payouts, or distributions, one option is to determine the current value of future payments and split that amount to determine a new annuity valuation.

In this case, the difference between what your annuity is worth and what you’ll receive in cash is called a discount rate. The average discount rate ranges from nine to 18%. The discount is the tradeoff for the ability to tap into your money immediately. It helps the insurance company make up for the profit they would have made if the annuity payments continued and the policy stayed in force.

For annuities that have not yet begun payments, the choices for distributing the proceeds are a bit more simple and include: 

• Withdrawing and distributing funds 
• Transferring your share to other accounts 
• Buying a new annuity contract
• Transferring the whole annuity contract to the other party

Withdrawing and Distributing the Funds

The parties in a divorce can choose to withdraw a portion of the value of an annuity or surrender the entire value and receive the proceeds in a lump sum. The money can then be split between the two individuals. Remember that a large withdrawal from an annuity may be subject to fees that will reduce benefits, including death benefits.

Transferring to Other Accounts

Divorced couples can choose to have surrendered proceeds transferred to another retirement account directly.

Funding New Contracts

One of the more popular ways of sharing assets is to divide an annuity from an existing contract and then create separate contracts for each participant. This means there would be a new contract for each party, with new contract values.

One option for a new contract is a conservative product called a fixed annuity, sometimes referred to as a multi-year guaranteed annuity (MYGA). Annuities from Canvas Annuity are one of the easiest MYGAs to buy, with very competitive interest rates.

Transferring Ownership

Instead of splitting the value of an annuity in a divorce settlement, the owner of an annuity product may choose to pass the ownership of the annuity to their ex-spouse. This essentially grants all rights and control of an existing annuity to the other party, where a new annuity contract goes into effect.

Divorce, Annuities, and Taxes

Every life insurance company that issues an annuity treats the division of that annuity as a withdrawal from the original contract. This withdrawal can trigger tax implications if not managed properly.

Unless a withdrawal is transferred to another annuity or retirement plan (if the annuity is a qualified annuity), it will trigger an IRS tax liability. The insurance company may have internal rules to decide which divorced spouse will be responsible for paying the taxes. If that’s not the case, the company will follow directions issued by the court.

Fortunately, avoiding tax penalties is relatively easy. In general, if the money is transferred and not withdrawn (meaning, the proceeds are used to purchase another annuity from the insurance company that issued the original annuity), then no tax event will be reported.

Even if the money is transferred to another qualified retirement plan like an IRA or used to buy an annuity from another insurance company, no taxes will be reported as long as the “withdrawal” is transferred directly. If the annuity funds are withdrawn and not transferred to another retirement product, this will likely trigger a taxable event.

Final Thoughts

Divorce is difficult and dividing assets during a divorce can be very challenging. Annuities can be especially tricky due to the different types of annuities, the tax status of the contract, and whether they have been annuitized or are still building tax-deferred interest.

So when dividing marital property, seeking the right tax advice is critical. This is especially important because each participant will need to build a separate retirement plan and determine what will make up the new retirement benefits package, including social security, a new annuity contract, and other products providing retirement income.

If conservative growth is part of the new plan, then a fixed annuity from Canvas Annuity may be a good addition to your retirement plan. Canvas features some of the best interest rates in the nation, and transactions can be managed online and agents are available to assist over the phone.