401k, divorce and taxable consequences
Divorce has happened, settlement agreement states that the one spouse must give $$$$ to ex-spouse from their 401k. Will the owner of the 401k (traditional) be taxed on this money being given to the ex-spouse or the ex-spouse who receives the money when they take a distribution? Can the receiver have the money sent as a direct rollover into the IRA they establish?
Permalink Submitted by Alan Spross on Mon, 2012-10-15 22:13
The spouses will need a QDRO in order to have a 401k plan split into two interests. This is a non reportable, non taxable transfer of an amount to the receiving spouse (known as the alternate payee).
Some plans will just separate the interests in an internal sub account, others will create a totally separate 401k plan for the alternate payee.
A distributions to the alternate payee as a result of a QDRO is taxable, but penalty free. However, if the alternate payee rolls the 401k over to an IRA, they lose the QDRO penalty exception and will have to wait until 59.5 in order to take penalty free IRA distributions.
Normally, the alternate spouse will be able to do a direct rollover to a TIRA account (but see penalty situation above). However, there are some plans that restrict distributions until the employee would have been eligible for distributions, and that depends on the plan itself. Most plans do not particularly want to hold assets for a non employee alternate payee, so it’s unlikely that they would not be able to get a distribution right after the QDRO is officially accepted by the plan.
The last thing the original spouse should do is to take a distribution with or without a QDRO and give it to the other spouse. This would be a taxable distribution to the employee owner and also subject to the penalty.
Permalink Submitted by Linda Randazzo on Tue, 2012-10-16 12:39
Thanks Alan,
Let me see if i am understanding your answer.
In this particular situation, the husband is planning to (if he is able) once they have the QRDO, to take his interest in the 401K and do a direct rollover to a TIRA into the institution of his choice.
Assumptions:
This should be no taxable event to the wife (owner of the 401K)
Taxation and penalty (if applicable) would occur once the alternate payee (husband) who is now the owner of the IRA takes a distribution.
Am i close?
Permalink Submitted by Alan Spross on Tue, 2012-10-16 16:41
Yes, you are correct.
First, the institution will review and approve the QDRO. They will then partition her 401k according to their procedures, most likely transferring the QDRO directed amount to a 401k plan for the husband. This is a non reportable transfer.
If the plan allows him to do an IRA direct rollover, that will be reportable but non taxable. It is means he could probably take a distribution directly from the 401k instead of the rollover. If he takes money out of the IRA, it will be taxable and he will also lose the QDRO penalty exception unless he is 59.5. Therefore, if he is going to need funds from this settlement before age 59.5, he would leave the 401k in place so he could take penalty free distributions directly from the 401k. Then he would roll it over at 59.5 to an IRA.