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How to Distribute Retirement Assets Settled in a Divorce
by Cathy Pareto, MBA, CFP®, AIF®
by Cathy Pareto, MBA, CFP®, AIF®
Breaking up is hard to do. Breaking up is even worse when it involves money. Divorce is never an easy matter.
Surprisingly enough though, getting distributions before age 59 ½ from retirement accounts settled through a divorce
is not that tough.
When retirement assets (including a 401k) are part of the divorce settlement, the spouse may qualify for penalty free
distributions before the age of 59 ½ using a qualified domestic relations order (commonly referred to as QDRO). This
is great for spouses who are unemployed or need supplemental income after a divorce. Issued under the domestic
relations law of a state, a domestic relations order is a court decree that gives an alternate payee the right to receive
total or partial benefits that would be payable to a participant under the plan.
QDROS are used to transfer money from a 401k (or other Qualified Plans) to an ex-spouse s IRA. The ex-spouse
maintains the tax-deferral benefits that any other traditional IRA would have, and are also subject to the same
restrictions.
With a QDRO, the tax code also allows for the money to be distributed directly to the ex-spouse without paying the 10%
penalty. Of course, ordinary tax rates would still apply. This alternative would best be used in cases where the
spouse needs an immediate lump sum.
For example, funds could be used for a new home purchase, legal fees, new furniture, or whatever. All or a portion of
the funds may be distributed in this manner. You may elect to have some distributed directly for immediate expenses
and the rest rolled into an IRA, but the rollover must occur within 60 days. Once the assets are transferred directly to
the ex-spouse, they cannot later be deposited to that spouse s IRA. Obviously unless you re in dire need for some
immediate cash, it s usually in your best interest to take advantage of the tax deferral benefits of an IRA.
This QDRO method is applicable for employer sponsored retirement plans, not IRA s. Some plans, however, do not
permit lump sum distributions to anyone.
You don t need a QDRO to divide IRA accounts, but very careful planning is highly recommended. A direct rollover from
one spouse s IRA to the ex spouse s IRA can be done if and only if outlined in the divorce settlement.
Penalty free distributions (before age 59 ½) from qualified retirement assets are allowed, but the rules are pretty
inflexible. Qualified plans include, but are not limited to IRAs, 401k, Keoghs, SEPs, money purchase pensions. The
tax code Section 72t allows for equal periodic payments to be taken from a retirement account penalty free. What s the
catch? There s no catch really, but the deal is the amount must be fixed (absolutely no changes) and the account
owner must take payments for five years or until the owner has reached age 59 ½ (whichever is longer). If any of the
above criteria are not met, the 10% penalty plus additional interest may be due.
Distributions may be taken at least once per year, but account owners may take them monthly if they wish. Once the
five year (or longer) period is reached, account owners are eligible to change or cease payments.
The downside of this alternative is that you get locked into distributions for at least five years, oftentimes even longer.
This method is a great tool for supplementing or permanently replacing income. But, what happens if you find a part
time job to supplement your income after you ve started 72t withdrawals?
Continuing to take distributions from your IRA when you don t need the money is a sure fire method to deplete your tax
deferred dollars. But, once you ve started you can t stop unless you fork over some hefty fines. In some cases, that
may be a better alternative than running the risk of exhausting your funds.
There is a graceful way to prevent this pitfall; but you ve just got to be a little creative. Legally, nothing prevents you
from splitting your IRA into various IRAs. You can use one to fund your 72t distributions and the other you can set
aside for growth. Determine the absolute bare bones minimum that you can live on for any extended period of time,
plug in an assumed growth rate and factor in the IRS reasonable interest rate to arrive at a total amount that will
sustain those withdrawals. This allows you a greater amount of flexibility over your distributions. In the event that the
amount you set is not enough to cover expenses, you can always split the growth IRA again, open a new account and
start the 72t distributions from the new IRA. All of this is perfectly legal and allows you to exert greater control of future
distributions.
Retirement benefits, for many couples today, are often the most substantial assets in the marital estate. In many
states, retirement benefits accumulated during the course of the marriage are divided equally. While divorce is not a
matter to be taken lightly, there is some light at the end of the tunnel for spouses depending on income from
retirement assets. But, the options must be carefully considered. Anyone facing a divorce should consult a financial
planner, in addition to their divorce attorney, to help them assess their needs and the most appropriate distribution
strategies going forward.
Surprisingly enough though, getting distributions before age 59 ½ from retirement accounts settled through a divorce
is not that tough.
When retirement assets (including a 401k) are part of the divorce settlement, the spouse may qualify for penalty free
distributions before the age of 59 ½ using a qualified domestic relations order (commonly referred to as QDRO). This
is great for spouses who are unemployed or need supplemental income after a divorce. Issued under the domestic
relations law of a state, a domestic relations order is a court decree that gives an alternate payee the right to receive
total or partial benefits that would be payable to a participant under the plan.
QDROS are used to transfer money from a 401k (or other Qualified Plans) to an ex-spouse s IRA. The ex-spouse
maintains the tax-deferral benefits that any other traditional IRA would have, and are also subject to the same
restrictions.
With a QDRO, the tax code also allows for the money to be distributed directly to the ex-spouse without paying the 10%
penalty. Of course, ordinary tax rates would still apply. This alternative would best be used in cases where the
spouse needs an immediate lump sum.
For example, funds could be used for a new home purchase, legal fees, new furniture, or whatever. All or a portion of
the funds may be distributed in this manner. You may elect to have some distributed directly for immediate expenses
and the rest rolled into an IRA, but the rollover must occur within 60 days. Once the assets are transferred directly to
the ex-spouse, they cannot later be deposited to that spouse s IRA. Obviously unless you re in dire need for some
immediate cash, it s usually in your best interest to take advantage of the tax deferral benefits of an IRA.
This QDRO method is applicable for employer sponsored retirement plans, not IRA s. Some plans, however, do not
permit lump sum distributions to anyone.
You don t need a QDRO to divide IRA accounts, but very careful planning is highly recommended. A direct rollover from
one spouse s IRA to the ex spouse s IRA can be done if and only if outlined in the divorce settlement.
Penalty free distributions (before age 59 ½) from qualified retirement assets are allowed, but the rules are pretty
inflexible. Qualified plans include, but are not limited to IRAs, 401k, Keoghs, SEPs, money purchase pensions. The
tax code Section 72t allows for equal periodic payments to be taken from a retirement account penalty free. What s the
catch? There s no catch really, but the deal is the amount must be fixed (absolutely no changes) and the account
owner must take payments for five years or until the owner has reached age 59 ½ (whichever is longer). If any of the
above criteria are not met, the 10% penalty plus additional interest may be due.
Distributions may be taken at least once per year, but account owners may take them monthly if they wish. Once the
five year (or longer) period is reached, account owners are eligible to change or cease payments.
The downside of this alternative is that you get locked into distributions for at least five years, oftentimes even longer.
This method is a great tool for supplementing or permanently replacing income. But, what happens if you find a part
time job to supplement your income after you ve started 72t withdrawals?
Continuing to take distributions from your IRA when you don t need the money is a sure fire method to deplete your tax
deferred dollars. But, once you ve started you can t stop unless you fork over some hefty fines. In some cases, that
may be a better alternative than running the risk of exhausting your funds.
There is a graceful way to prevent this pitfall; but you ve just got to be a little creative. Legally, nothing prevents you
from splitting your IRA into various IRAs. You can use one to fund your 72t distributions and the other you can set
aside for growth. Determine the absolute bare bones minimum that you can live on for any extended period of time,
plug in an assumed growth rate and factor in the IRS reasonable interest rate to arrive at a total amount that will
sustain those withdrawals. This allows you a greater amount of flexibility over your distributions. In the event that the
amount you set is not enough to cover expenses, you can always split the growth IRA again, open a new account and
start the 72t distributions from the new IRA. All of this is perfectly legal and allows you to exert greater control of future
distributions.
Retirement benefits, for many couples today, are often the most substantial assets in the marital estate. In many
states, retirement benefits accumulated during the course of the marriage are divided equally. While divorce is not a
matter to be taken lightly, there is some light at the end of the tunnel for spouses depending on income from
retirement assets. But, the options must be carefully considered. Anyone facing a divorce should consult a financial
planner, in addition to their divorce attorney, to help them assess their needs and the most appropriate distribution
strategies going forward.
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