Annuities & Divorce: Assets Between Ex-Spouses

Whether annuities are protected from division in a divorce depends on the timing of when the annuity was purchased. If your annuity was purchased prior to your marriage, then it may be protected from the rules of splitting marital assets in divorce proceedings. However, if the annuity was purchased during your marriage, it is likely subject to the division of property.

The involvement of the issuing insurance company makes annuities complex in divorce proceedings, especially when both spouses paid premiums.

Financial implications to be considered when holding an annuity during a divorce are the contract’s cost basis, surrender charges, living and death benefits and interest rate guarantees.

It is important to understand how annuities are treated in divorce settlements. To make informed decisions about asset division, a financial advisor should also be involved.

Annuities can be divided between ex-spouses by directly withdrawing half the account value or offsetting it with other assets. A qualified domestic relations order (QDRO) may be required to divide the annuity contract and other assets, such as 401ks, pension plans and other qualified retirement accounts.

There are factors that determine how annuities can be divided. Specific to the terms of the annuity contract, some insurance companies may not allow lump-sum payments or for a single annuity to be split. A QDRO isn’t required to split a non-qualified annuity. However, if the insurance company doesn’t allow splits, it may trigger a taxable event pursuant to a divorce decree.

Without a divorce decree, splitting the annuity could incur tax consequences in the form of a 10% penalty if the owner is not at least age 59 ½. Dividing the annuity assets up and distributing them as a lump sum can be complicated, especially if the annuity income has already started paying out. To avoid the hassle of splitting up the annuity, the overall division of other marital assets may be necessary.

When transferring ownership of an annuity contract to an ex-spouse, there are options. The annuity can be transferred into an ex-spouse’s IRA, or the original annuity contract can be canceled and that money used to purchase a new annuity by the ex-spouse. A new surrender period will begin with the new annuity. Typically, this requires the cooperation of the insurance company or financial institution that holds the annuity.

It is essential to follow proper procedures — such as working with a qualified attorney or mediator — to ensure compliance with applicable laws and regulations.

In certain circumstances, annuities may be transferred to a spouse in a divorce decree. Fixed or variable deferred annuities can be transferred if payments have not begun yet or if they haven’t been annuitized. Immediate annuities cannot be transferred.

Canceling the contract before maturity may result in surrender charges. Surrender charges are determined in which year the contract is canceled and can range from 1% to 10%. Depending on the provisions of the contract, both ex-spouses may owe surrender charges.

When an annuity contract transfers between former spouses and the transfer is related to the cessation of marriage or occurs within one year of the date that the marriage legally ended, it is exempt from tax. The tax-deferred status of the annuity continues with the transfer to the spouse.

However, withdrawing funds early without transferring them to another annuity does result in taxation.

This annuity income could put the spouse in a higher tax bracket, further increasing their tax liability.

A viable alternative for ex-spouses seeking immediate liquidity is surrendering or selling the annuity payments for a lump sum. Be mindful that if you choose to surrender the annuity before it matures, a penalty in the form of a surrender charge may be applied.

Another option that avoids surrender charges is selling the annuity contract to a third-party company. The buying company applies a discount rate to the annuity that could shave off 9% to 18% of the contract’s value, and then the difference is paid to you upfront. If you choose to sell your annuity contract, any lump-sum payment exceeding the annuity contract will be taxed as ordinary income.

Consider consulting a tax professional or financial advisor to ensure you understand all tax implications and make an informed decision.