By FPA member Carol Khouri, CFP®, CDFA™
Last Updated: June 20, 2011
Generally, withdrawing funds from a tax deferred retirement plan prior to age 59 ½ will result in a 10 percent penalty (in addition to the distribution being taxable as ordinary income).
For divorcing couples, tax Reg (72)(t)(2)(C) allows distributions from a qualified plan without a 10 percent penalty, in accordance with what is written in the QDRO (Qualified Domestic Relations Orders). This is helpful when monies are needed and the main source of funds is a qualified retirement plan.
Jane, age 57, is finalizing her divorce. According to the division of assets, Jane was awarded the following:
- Savings: $50,000
- Individual Retirement Account (IRA): $400,000
- John’s 401(k): $390,000
Jane discovers she needs $75,000 to pay bills. Her attorney can write into the QDRO a provision to have money withdrawn from the 401(k) plan without her incurring the 10 percent penalty. When exercising this provision, be aware of the mandatory 20 percent federal income tax withholding from a qualified plan. In this example, Jane’s attorney needs to request a withdrawal of $93,750 to receive $75,000.
If there are no other assets except for retirement assets (Jane needs supplemental income), regulation 72(t)(2)(a)(iv) allows for substantially equal periodic payments. Distributions need to be made over her life expectancy or the life expectancies of herself and her designated beneficiary. The series of payments must remain in place for five years or age 59 ½, whichever comes later. If the payments are modified (except for death or disability) during the time period, the exemption is lost. If a modification is made to the payments, the tax for that year is increased by the amount that would have been imposed, plus interest.
FPA member Carol Khouri, CFP®, CDFA™, has worked in the financial industry for more than 20 years. Her objective is to gain a clear understanding of clients’ long-term goals, objectives and expectations in order to customize a strategy which allows them the opportunity to reach their goals. Carol also has expertise in divorce planning. As a Certified Divorce Financial Analyst™, she is qualified to assist clients in financial decisions to ensure an equitable division of assets.