Advanced Underwriting Consultants

Question of the Day – July 18

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Here’s the question of the day.

Question: My client recently divorced her husband.  She is collecting defined benefit pension benefits from his plan pursuant to a QDRO.  She is also collecting substantial alimony, and does not have any other earned income.  Can she make a deductible traditional IRA contribution?

Answer: Probably yes.

IRS Notice 87-16 says that a divorced spouse who is simply receiving pension distributions from her ex-husband’s qualified plan is not an active participant in the plan.

Here are two key excerpts:

A4: If a married individual obtains a divorce during his or her taxable year (and does not remarry during such year), is the individual considered an active participant merely because the former spouse is an active participant for the year?

A: No. Marital status is determined as of the end of the year. Thus, if the individual is not married at the end of the year, the fact that his or her former spouse is an active participant will not cause the individual to be treated as an active parti cipant. Similarly, if an individual marries during the year, and the individual’s new spouse is an active participant, the individual shall be treated as an active participant for the entire year if the couple files a joint tax return.

A8: Is a retired individual who is receiving pension annuity payments an active participant?

A: No. An individual will not be treated as an active participant merely because the individual receives benefits under a retirement arrangement described in section 219(g)(5) of the Code.

A person receiving alimony is eligible to use that income to make a traditional IRA contribution.  Someone who is not an active participant in a qualified plan is able to deduct the contribution from federal income taxes without regard to her taxable income.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – November 17

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers.  Here’s the question of the day.

Question: My 50 year old client is in the process of getting divorced.  Her husband is a participant in a 401K plan.  They’ve worked out a deal for the husband to transfer $100,000 from the plan to her, pursuant to their divorce.  What are the tax implications?

Answer: Under normal circumstances, the husband would have to pay income taxes on the plan distribution, plus any applicable penalty tax.  To avoid that tax result, the parties should divide the plan pursuant to a qualified domestic relations order (QDRO).

A QDRO is a judgment, decree, or order that relates to the provision of child support, alimony, or property rights to a spouse, former spouse, child or other dependent.  There are a few other technical requirements.

A QDRO cannot provide an alternate payee with any form of benefit not otherwise available to the plan participant.

A direct distribution from a pension to the non-participant spouse pursuant to a QDRO is taxable but not subject to the pre-59 ½ 10% penalty tax.  If that’s done in the example above, the wife would pay income tax on the 401K balance she receives, but not the penalty tax.

The alternate payee can also roll over the QDRO distribution to her own IRA tax-free.  If the rollover is done, the receiving spouse loses the ability to get penalty tax free pre-59 ½ distributions.

A QDRO-like opportunity also exists for an IRA to be split and rolled over by the non-participant spouse tax-free to his or her retirement account.  However, if an alternate payee of an IRA who is younger than 59 ½ decides to keep the distribution, the payee will be potentially liable for both income tax and penalty tax.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.