Getting divorced and need cash?
Often in divorce, there is a need for cash. You might need to purchase a new home, move, pay attorney fees, pay college tuition, or any number of things. Cash is often scarce. An option for getting cash is from one the largest assets in many marriages, the 401(k) plan. Did you know you have the option of taking a distribution of all or a portion of the 401(k) account in cash before age 59 ½ without paying the 10% early withdrawal? Many divorce professionals are unaware of this exception to the 10% early withdrawal penalty.
How to avoid the early withdrawal penalty from the IRS.
To avoid the 10% early withdrawal penalty, you must take the distribution “incident to divorce”. To be clear, you cannot be the plan participant in the 401(k) plan. The 401(k) account has to be your spouse’s. Also, don’t forget that the 401(k) plan distribution is still subject to ordinary income tax (unless the money was from a Roth contribution).
Splitting a 401(k) plan does require some extra paperwork. You will have to get a special document prepared called a Qualified Domestic Relations Order (QDRO). But it can be worth it if you need a source of cash.
To avoid the 10% penalty, at the time of distribution pursuant to the QDRO, you will instruct the 401(k) plan administrator that you want all or a portion of the amount paid directly to you. Whether or not a cash distribution will be taken does not have to be decided upon during the divorce settlement. It doesn’t have to be spelled out in the QDRO either. However, the distribution of cash must be directly from the plan. If you decide to roll the funds over to an IRA or another 401(k) or leave the money in the 401(k) plan for later, you can’t change your mind and get this cash before age 59 ½ without paying the 10% early withdrawal penalty. This is your one time chance!!
This doesn’t apply to IRAs.
This exception to the 10% penalty does not apply to splitting up IRAs, only qualified plans like 401(k) plans.
A CDFA can help you!
Dividing retirement funds in a divorce can be very complicated. It’s important to discuss the consequences and the best way to divide assets with a Certified Divorce Financial Analyst. A Certified Divorce Financial Analyst may also be able to help you get that QDRO prepared a lot cheaper than your attorney can!