Advanced Underwriting Consultants

Question of the Day – November 17

Ask the Experts!

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.