divorce settlement
I have a client who was recently divorced age 47 and is receiving retirement plan money from the ex. One of the plans has after tax contributions listed on the rollover distribution. The check came as one lump sum. Should after tax amount go into a separate IRA so not to comingle with the pre tax money.
Permalink Submitted by Alan Spross on Tue, 2011-09-13 22:33
If any funds are rolled to an IRA, the after tax amounts are considered a pro rated part of the IRAs whether they are in a separate account or not. Therefore there is no benefit or reason to open a separate account IF the funds are to be rolled into a TIRA.
But there are other options to consider here. I assume the client secured a QDRO and the funds are coming from the ex’s qualified retirement plan(s). Client may wish to roll the pre tax amounts to a TIRA and the after tax amounts to a Roth IRA once the pre tax amount is rolled over. This would amount to a tax free conversion of the after tax amounts. But if the client needs the pre tax TIRA money before age 59.5, there will be a penalty unless they start a 72t plan and age 47 is very early to start such a plan. Therefore, client may need to keep the after tax money for expenses instead of putting it into either type of IRA.
And if client wants to keep some of the pre tax money, there is no penalty under the QDRO exception, just ordinary taxes. But once in an IRA, there will be a penalty until 59.5 on the pre tax amounts distributed.
So it all boils down to how much client will need prior to 59.5 and when.
Permalink Submitted by Jon Heller on Wed, 2011-09-14 13:31
Thanks for the response. Since I have in possession the check from the rollover which includes the after tax contributions, how would she be able to avoid the penalty if she wanted the money. Would we need to go back to the custodian and have them cut two checks. Thanks
Permalink Submitted by Alan Spross on Wed, 2011-09-14 16:32
If the check originated from a qualified plan pursuant to a QDRO, there is no penalty under a specific penalty exception. But any pre tax funds rolled to an IRA would be subject to penalty if they are distributed from the IRA before 59.5 (barring adoption of a 72t (SEPP) plan).
There is no need for two checks. For funds she does NOT roll to an IRA, there is a pro ration between the pre tax and after tax amounts. For example, if the total check was for 100k and 20k of that amount was after tax, then 20% of any amount she does not roll over is tax free. But ALL of it is penalty free.
Now, if she decides to roll over some of the money to an IRA, the first dollars rolled over are deemed to be pre tax amounts. That means if she rolled over 50k, all 50k in the above example would be pre tax. The remaining amounts would then be 30k pre tax and 20k after tax. If she kept that 50k, then 30k of it would be taxable.
She could also incorporate a Roth IRA rollover (conversion) into this process. In the above example, if she rolled the pre tax 80k to a TIRA account, she would have the 20k after tax amount to convert to a Roth IRA tax free. Then, if she needs money she can take distributions from the Roth IRA tax and penalty free. There is no 5 year conversion holding period for this conversion because the entire 20k was after tax. If she needed it, she could take it out tax free and if she did not, it would then grow potentially tax free once the Roth was qualified.
There are alot of mix and match choices here, but it is important to do any rollovers in a specific order because of the rules cited above. It can get quite complex.