Community Property in Allocating a Self-Directed IRA
In cases of divorce or inheritance, who gets the Self-Directed IRA? It sounds like a simple question, but anything having to do with finance and government rules is almost never simple. Any time assets need to be allocated, there is often a complicated mix of federal laws, state regulations, and personal circumstances. In the case of deciding ownership of a Self-Directed IRA, those rules will vary from state to state. Some do not have specific rules and instead will rely on Federal guidelines. Other states have distribution rules in place, and one of the more prominent ones is known as community property.
What is Community Property?
Community property is a concept that defines who owns what assets within a marriage. In community property states, any assets acquired or earned during the course of the marriage belong to both partners in the marriage. Usually, the distribution will be equal, although there are some locations that will consider different percentages. The community property regulations reflect the idea that in a marriage both spouses play contributory roles, even if one spouse's role is more focused on income. If the couple has executed a prenuptial agreement, that will normally take precedence over the community property laws.
States that do not possess community property laws are known as common law states. In those states, the property remains with the individual who acquired it and is not split.
Who Gets the Self-Directed IRA?
In a state which does not possess community property regulations, the Self-Directed IRA will be distributed to the beneficiaries listed in it. This is true even if there is a legal will that says otherwise. In such a case, if the IRA has the couple’s children listed as beneficiaries, but not the account holder’s spouse, the IRA will be distributed only to the children listed.
However, that is not the case in a state with community property regulations. With community property, the spouse is automatically considered an owner/beneficiary of the Self-Directed IRA, even if they are not designated in the beneficiary list. The rules go so far as to say that in order for the spouse to be removed as the primary beneficiary, they would have to fill out and sign a form attesting to the fact that they are giving permission for other beneficiaries to be listed.
One exception to this rule will be assets acquired before the marriage took place. If the bulk of the funds in the Self-Directed IRA were already there before the couple was married, then the spouse would not automatically be the primary beneficiary. The regulations in this scenario are case-sensitive and would need to be discussed with a knowledgeable financial professional.
Community Property – State by State
Community property is a state-level rule and consequently can differ in its application between states. The fundamental idea will always be the same – assets acquired during the marriage will be split evenly. However, as in all financial considerations, the details can make a world of difference. There are currently nine community property states and three which have optional systems. Let’s look at each and examine some of the state-specific rules. (Some of the rules listed below can apply to more than one state.)
- Community property laws apply to all property acquired during the marriage.
- Exceptions include gifts made to a specific spouse, inheritance, and post separation acquisitions.
- If a property was owned by the individual before the marriage, and then accrued profit during the marriage, the profit is not considered community property.
- All income, property, and debt incurred during the marriage is subject to a 50/50 split.
- The split takes place according to the total net value of all assets, and may be distributed by asset allocation.
- Although gifts and inheritances are normally exempt from community property, if they had been deposited in a joint account, then the rules can change.
- Standard community property rules exist.
- Exceptions to this rule are known as “separate property”. They include property owned prior to marriage, gifts, property acquired with separate property, and property that has been designated to one spouse specifically via written agreement.
- The split will normally be even unless there are compelling reasons that indicate otherwise. Some of these reasons include length of marriage, the presence of a pre-nuptial agreement, level of post-marriage spousal support, and the presence of retirement benefits.
- Standard community property rules with exceptions including inheritance, pre-marriage acquisitions, and certain damages.
- If a couple wishes to make a separate property agreement after they are already married, they may do so but it will require court approval. Prior to marriage an agreement may be executed without approval.
- Community property laws also regulate how a married individual may buy or sell property during the marriage.
- Community property is split 50/50. Exceptions include a valid agreement stating otherwise, or if a court finds that one of the spouses acted unethically with the property.
- Neither spouse may give away or sell property unless the other spouse agrees as well. Additionally, a spouse may not bequeath more than 50% of the property in their will.
- Separate property can become community property if it is placed in a joint account and does not possess any way of distinguishing it.
- Debt incurred during the marriage is considered community debt. One important exception is gambling debt which remains separate to the spouse that incurred it.
- “Secret” assets and debt (e.g. an undisclosed credit card,) retain the community property designation.
- Separate property can become partial community property. One such example is where one of the individuals made a down payment on a house before marriage but mortgage payments were made by the couple after marriage.
- Community property does not need to be split exactly in half, but rather a “just and right” division will be made by the court. Factors include child custody, earning capacity, and fault in breakup of the marriage.
- Similarly, community debt need not be split equally. If a person unknowingly opened a credit card in the name of their spouse, theoretically the debt could be shared, but a strong case could be made for identity theft.
- Separate property includes gifts jewelry given from one spouse to the other, inheritance, and personal injury settlements.
- The court will make an equitable split, although not necessarily an even one. Ideally the court will be looking to equalize the financial status of the spouses.
- In rare circumstances, separate property can be awarded by the court to the other spouse.
- For short marriages, (usually less than five years,) the court will try to divide the assets to place each spouse in the position that they were before the marriage.
- In Wisconsin, community property is known as “marital property”.
- If a property was acquired before marriage, but then rose in value during the marriage, the increase in value is considered community property.
- An inheritance deposited into a joint account can take on a community property designation.
States which have optional community property regulations are Alaska, South Dakota, and Tennessee.
Questions about Self Directed IRAs and community property?