Penalty-free Access to Retirement Funds in Divorce

Penalty-free Access to Retirement Funds in DivorceThe division of retirement accounts is often one of the many issues that needs to be addressed in a divorce matter. Although trying to retain retirement accounts you may be awarded in divorce is often advisable, you may also need some of these funds in order to secure housing, pay off debts, or just to maintain your standard of living. If most of you and your spouse’s savings are tied up in retirement with an employer, then liquidation of all or a portion of your share in your spouse’s qualified retirement plan may be an option to consider.

Typically, any withdrawal from a retirement plan prior to age 59½ is subject to a 10% early withdrawal penalty and income taxes. However, if your divorce settlement awards you a portion of your spouse’s 401(k), 403(b) or other Defined Contribution Plan pursuant to a Qualified Domestic Relations Order (QDRO), you (as the non-employee spouse) are permitted to make a one-time withdrawal without having to pay the normal 10% penalty, even if you have not reached age 59½. In order to avoid the penalty:

  1. The plan must be a qualified plan covered by ERISA (e.g., 401(k) or 403(b)). It does not apply to IRAs;
  2. A Qualified Domestic Relations Order (QDRO) must be drafted and approved as an Order by the Court directing how the plan is to be divided. It must also be approved by the Plan Administrator as being compliant with the terms of the Plan;
  3. The funds can only be paid to the non-employee spouse (a/k/a alternate payee), and not the owner of the account;
  4. The withdrawal request must be made before rolling over the funds into an IRA or other qualified plan. If you first roll the money into an IRA or other qualified plan in your name and then make a withdrawal, you will be subject to the standard 10% early withdrawal penalty if you are under age 59½.

Of course, any monies you withdraw are still subject to federal taxation as income to you. Most plans will withhold 20% of any funds you withdraw as pre-payment of taxes. As a result, this 20% withholding should be taken into consideration when determining how much you will need to withdraw so that you obtain the net amount you want. Further, depending upon your income level, your taxable rate may be higher than 20%; therefore, you should also consult with an accountant or financial advisor to determine if additional monies should be set aside to pay these taxes later on when you file your annual return.

Division of retirement assets can be complicated and confusing. Our team of experienced professionals can assist you in drafting a well-written divorce agreement which can help you avoid issues down the road. We cover Nashua and most of New Hampshire. Call us today, (603) 883-0797, to schedule your free half-hour consultation.

The author is Michael J. Fontaine. Esq.
Co-authored by Wendy Borrun, WWF Paralegal

This blog is intended for informational use only. The information contained herein should not be construed as offering legal advice or a legal opinion.