When a couple divorces, it is not unusual for the retirement plan of one or both spouses to be the most significant asset that must be divided. If the plan is a “Qualified Plan” such as a Defined Benefit or 401k, the plan may be divided between the spouses using a Qualified Domestic Relations Order (QDRO).
A QDRO not only allows for the tax-free division of the plan’s assets, but distributions from Qualified Plans pursuant to a QDRO are not subject to the 10% penalty for early withdrawal. Regardless of the age of the spouse receiving the QDRO distribution, no early withdrawal penalty applies (IRC Section 72(t)(2)(c)).
However, the tax treatment of the division of IRAs in divorce is vastly different than that of Qualified Retirement Plans. Although one could make the argument that a QDRO could provide for the tax-free division of an IRA in a divorce, there is no requirement that a QDRO be in place to avoid tax when dividing an IRA in divorce proceedings (IRC Section 408(d)(6)).
Even if a QDRO is in place, it will absolutely not protect you from the 10% early withdrawal penalty from a nonqualified retirement plan such as an IRA (IRC Section 72(t)(3)(A)). The 10 percent early withdrawal penalty applies (subject to certain exceptions) to distributions that are taken from IRAs and other retirement plans when you are under age 59 ½.
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About David Ellis CPA
David Ellis is the managing partner of Ellis & Ellis, CPAs, Inc. located in Pasadena, California. He has over 30 years of experience in the practice of Divorce, Trust/Estate, and other family tax matters