401(k)

In many divorces, the 401k is one of the largest assets. The size of these accounts and their tax treatment, means that there are specific strategies and pitfalls to be aware of with regards to 401(k) and  divorce.

  1. When part of a divorce decree, clients can withdraw money from a 401(k) without incurring the 10% early withdrawal penalty that normally applies when the account holder is under 59 ½. This may be an effective way to pay off marital debts when necessary. The one specific pitfall attached to this strategy is that if the assets are transferred to the client’s IRA as part of a QDRO, then the 10% early withdrawal penalty cannot be avoided. The person receiving the 401(k) proceeds is entirely responsible for the taxes owed on any withdrawals. When assets are to be withdrawn from a 401(k), there should be a clear plan of who will pay the taxes owed, how it will be paid, and what debts it will address.
  2. The other issue with 401(k) and divorce planning is that, if the client is under 59 ½ , 401(k) is an illiquid asset. A client who is under 59 ½ and withdraws 401(k) money will, typically, owe taxes and 10% penalty on the proceeds. This means that a divorce in which a client gets $500,000 in savings, while the other client gets a $500,000 401(k) account is not an equal distribution. The person receiving the 401(K) will owe taxes, and possible 10% penalty if under 59 ½, while the person receiving the savings account gets access to the full account value. Clients should consider an review the tax status of assets they are fighting for or are being awarded since these decisions are typically final. When part of a divorce decree, clients can withdraw money from a 401(k) without incurring the 10% early withdrawal penalty that normally applies when the account holder is under 59 ½. This may be an effective way to pay off marital debts when necessary. The one specific pitfall attached to this strategy is that if the assets are transferred to the client’s IRA as part of a QDRO, then the 10% early withdrawal penalty cannot be avoided. The person receiving the 401(k) proceeds is entirely responsible for the taxes owed on any withdrawals. When assets are to be withdrawn from a 401(k), there should be a clear plan of who will pay the taxes owed, how it will be paid, and what debts it will address.
  3. QDRO – when a couple divorces, Individual Retirement Accounts may be divided by a regular court order or judgment. Clients should be aware of the tax consequences and potential delays involved in the transfer of IRA funds when negotiating their divorce settlement. Federal law allows tax-free transfers if specified for in your divorce decree or property settlement agreement, AND the funds are transferred directly from one spouse’s IRA to the other spouse’s IRA.  Dividing or transferring IRA funds without following these rules could create unexpected tax consequences. If you are involved in a divorce proceeding, be sure to ask your company’s plan administrator if there is a model QDRO form for your plan. Doing so early on in the process will save you time and expense.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.Securities offered through Securities America, Inc. Member FINRA/SIPC. Advisory services offered through Provo Wealth Management Group. Securities America is not affiliated with any other named entity.  This site is published for residents of the United States and is for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any security or product that may be referenced herein. Persons mentioned on this website may only offer services and transact business and/or respond to inquiries in states or jurisdictions in which they have been properly registered or are exempt from registration. Not all products and services referenced on this site are available in every state, jurisdiction or from every person listed. Securities American and its representatives do not provide legal advice; therefore it is important to coordinate with your legal advisor regarding your specific situation. 

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