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Divorce and 401(k)s and IRAs – Part 3

{4:54 minutes to read}

Divorce and 401(k)s and IRAs - Part 3 by Ada HasloecherIn Part 1 and Part 2 of BJ Mann’s article on retirement plans and divorce, we talked about retirement funds in general and the differences between 401(k)s and IRAs. Now to the topic of dividing the plans.

No matter how these plans are divided (equally or some other sharing arrangement), the math must be done first. Then, the parties must adhere to the plan’s specific set of directives for dividing the monies so that the “alternate payee” receives his or her monies directly from the plan administrator at the time of retirement. As a general rule, these monies are taxable (with the exception of some plans – which you will see), so it’s important that the plan pay the “alternate payee” directly so they can be responsible for their own taxes on the earnings. We start with the 401(k)-type plans:

Divorce and 401(k)s and IRAs – Part 3

Sharing a 401(k)-Type Plan or IRA Through Divorce

Both 401(k)s and IRAs have rules and regulations regarding the maximum annual contribution and under what terms you can withdraw funds. The key points are:

  • There are penalties for withdrawing retirement funds prior to age 59-1/2.
  • These funds are generally invested in stocks and mutual funds so they are subject to the volatility of the financial markets.

The method required to share a 401(k) versus an IRA during a divorce has some special (but not complicated) considerations. First and foremost, regardless of whether you are over or under age 59-1/2, do not withdraw retirement funds directly and give the funds to your spouse. The distribution needs to be part of the divorce decree to avoid unanticipated taxes and penalties.

Sharing a 401(k)-Type Plan

Let’s use a fictional divorcing couple as an example. Ellen has a 401(k) of $30,000 and Jeff has a 401(k) with $70,000. They want to share the total assets of the 401(k)s equally between them. The total is $100,000, and 50% is $50,000.

Because Ellen already has $30,000 in her 401(k), she would be owed $20,000 from Jeff’s account. Then she would keep 100% of her own account.

If the distribution is processed through a QDRO (see below), the following applies:

  1. There are no taxes or penalties to Jeff, the owner of the 401(k) from which funds are being taken to give to Ellen.
  2. Ellen has the option to put her share of Jeff’s 401(k) into a tax-deferred account such as an IRA. Then she will pay no taxes or penalties.
  3. Ellen also has the option to take some or all of her distribution in cash. Ellen will pay taxes but no early withdrawal penalties on the amount she takes in cash.

Other Considerations

  1. The distribution of these funds can only take place after the Judgment of Divorce is signed.
  2. To process the distribution, a court document called a Qualified Domestic Relations Order (QDRO) must be signed by a judge. A QDRO (pronounced “kwa-dro”) is a legal document that tells your retirement account plan administrator how to divide the assets and that the division is pursuant to a divorce. As a QDRO is a legal document, there is typically a fee for a lawyer (or similarly trained professional) to create this document.
  3. The distribution of the funds lags several months following the divorce decree as the plan administrator of the 401(k) approves and processes the distribution.
  4. The option to take cash without penalties is a one-time only option and must be done before the funds are placed into another tax-deferred account.
  5. Taking cash without paying penalties is only an option when funds originate in a 401(k)-type investment. This is not an option when funds are taken from an IRA-type investment.

The last and final segment on this series will discuss sharing an IRA plan through divorce.

bj mannBJ Mann
Divorce • Family • Workplace Mediation
1121 Winton Road South
Rochester NY 14618
Office: 585.234.8740
Web Site: www.bjmediationservices.com

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Ada L. Hasloecher

Divorce Mediator / Center Founder
Divorce & Family Mediation Center, LLC
Phone: 631-585-5210
eMail: Info@DFMCLI.com
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