IRA/401(k) and divorce
I have a client who is getting divorced and he has to pay half of his 401(k) and rollover IRA funds to his wife. How should he do this to minimize his taxes?
I have a client who is getting divorced and he has to pay half of his 401(k) and rollover IRA funds to his wife. How should he do this to minimize his taxes?
Permalink Submitted by Alan Spross on Fri, 2011-07-22 19:38
FIrst, he should be sure his lawyer is conversant with QDRO law. To partition the 401k, he must secure a court approved QDRO which allows for transferring the determined portion of the 401k to the spouse. That is a non taxable transfer. A QDRO is not needed for an IRA, but a court order to transfer the IRA incident to divorce would do the same for the IRA, ie a non taxable transfer. Under a QDRO, the spouse could take penalty free distributions directly from the 401k if distributions are allowed by the plan. If the 401k has after tax contributions, the QDRO should be specific regarding the allocation of those contributions as they are obviously more valuable than the pre tax amounts. There also could be highly appreciated employer stock in the plan (NUA) and even a Roth 401k sub account, so the requirement for his attorney to be competent in all these complex issues is critical if the plan has a meaningful balance.
The worst thing he can do is to take a direct distribution from these plans because he would get stuck with the entire tax bill and early withdrawal penalty if under 59.5. If the settlement includes his taking distributions it should certainly be adjusted for the post tax proceeds. But there are so many options now, failure to be aware of them all can be extremely costly.
I am assuming there is no current 72t plan (SEPP) from any of his accounts now. If so, that is an entirely separate problem.