Advanced Underwriting Consultants

Question of the Day – October 14

Ask the Experts!

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

Question: My client is divorcing her spouse, and they are in the process of splitting up a pension plan balance.  What are the tax consequences of doing so?

Answer: When a taxpayer withdrew funds from his IRA in order to satisfy a divorce judgment, he was required to include the distribution in his gross income.  The Tax Court also ruled the distribution was subject to the 10% penalty imposed on early IRA withdrawals.

The divorce judgment failed to meet the requirements of a qualified domestic relations order (QDRO).

Under the facts of the case, taxpayer was required to pay his ex-wife a specified amount of money pursuant to their property settlement agreement.  In an effort to comply with the agreement, he attempted to transfer funds directly from his IRA to his former spouse.  She, however, refused to accept the transfer over concern that the funds would be taxable to her when she eventually received distributions from her IRA.  Ultimately, ex-husband simply withdrew the money from his IRA and delivered it directly to his ex-wife.  He did not report the IRA withdrawal on his return.

The Tax Court noted that retirement plan distributions made under a QDRO are not currently taxable to the taxpayer making the transfer. However the Court rejected taxpayer’s contention that the divorce judgment was, in effect, a QDRO.  According to the Court, the judgment only directed that he make a specific cash payment to his ex-wife.  It did not order him to withdraw funds from his IRA.  In addition, husband didn’t actually transfer an interest in the IRA to his former spouse.  Instead, he merely took a withdrawal and paid the funds to her.

 

In general, qualified retirement plans must provide that plan benefits may not be assigned or alienated.  However, a plan may distribute, segregate, or otherwise recognize the attachment of any portion of a participant’s benefits in favor of the participant’s spouse, former spouse or dependents, if such action is mandated by a QDRO.

A QDRO is a judgment, decree, or order (including an order approving a property settlement) that relates to the provision of child support, alimony, or property rights to a spouse, former spouse, child or other dependent (“alternate payees”); is made under a state’s community property or other domestic relations law; creates, recognizes, or assigns the right to receive all or a portion of a participant’s plan benefits to an alternate payee; and clearly specifies,

  • the name and address of the alternate payee,
  • the amount or percentage of the benefit to be paid,
  • the number of payments or period over which the order applies, and
  • each plan to which the order applies.

Strictly speaking, a QDRO applies only to an employer-sponsored retirement plan such as a pension or profit-sharing plan, but Code Section 408 sets out similar provisions for IRAs.

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

A QDRO may also specify that a former spouse of a participant be treated as the surviving spouse for purposes of survivor benefit requirements.  For this purpose, the former spouse will be treated as married to the participant for the requisite one-year period if such former spouse had been married to the participant for at least one year.

Under a QDRO, a spousal alternate payee (including a former spouse) is taxed like any other distributee of a qualified plan distribution.

The 10% premature distribution penalty which applies to qualified plan distributions taken prior to age 59-1/2 does not apply to payments made to an alternate payee pursuant to a QDRO.  This rule does not apply in the case of an IRA; distributions from an IRA not rolled over will be subject to the premature 10% distribution penalty.

If a spouse or former spouse of the participant receives a distribution under a QDRO, the rollover rules apply to such alternate payee as if the alternate payee were the participant. Thus, the alternate payee can avoid having to include such a distribution in his or her taxable income by rolling the money into an IRA within 60 days, or by asking the pension trustee to make a direct transfer.

For those helping clients make pension or IRA transfers pursuant to a divorce or separation, make sure it’s a QDRO.

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.