{5:00 minutes to read} What are the tax aspects of dividing retirement money by QDRO? The answer really depends on exactly how you want to take the money and what kind of plan you have.
No taxes are due when the QDRO is signed. Taxes only come into play when money is actually distributed from the plan.
With a monthly pension plan, the taxes become due when you actually receive a check or payment from the plan.
The transfer of money from a 401(k) plan to another 401(k) or to an IRA, does not result in taxes being due. Again, it is only when money actually comes out of your 401(k) or IRA that there are tax consequences.
NO Taxes
If the money being transferred stays in a retirement plan, NO taxes are owed. Just like the money already in the plan, there are no taxes until the money is taken out. If the former spouse would rather defer all taxes, he/she can “roll over” any lump sum distribution to an IRA or 401(k), where the funds can remain invested and continue to grow tax-free until retirement.
Except…
Monthly pension payments from a Defined Benefit Plan or a federal/state civil service plan cannot be rolled over into another plan or IRA. These distributions are taxable when received. In this situation, each of you pay your own taxes on the money you get from the monthly pension. When you receive money from a monthly pension, there will usually be withholding, and you will receive a separate W2P.
YES Taxes
If there are lump-sum cash distributions to a former spouse as a result of a QDRO, the distributions are taxable when received. The amount taken will be subject to an automatic 20% federal tax withholding, to be credited against the former spouse’s final tax bill for that year.
You can get a tax break, however. The usual 10% tax penalty for early distributions (under age 59½) does not apply to a distribution from a signed QDRO. If the former spouse is needing the money for other reasons (e.g., to pay debts or lawyer fees or to buy a new house), taking a lump sum distribution via a QDRO will avoid the 10% penalty, even if the distribution is still subject to income tax.
Be aware that you must request this immediate distribution prior to rolling any remaining funds into your own qualified plan or IRA. If you roll the funds over first and then withdraw them from your own Plan, you may needlessly re-subject yourself to the 10% penalty.
10% Penalty
The 10% penalty rule has its own peculiarities, especially with regard to an IRA. When money is taken out of an IRA, which usually does not require a QDRO, there is no way to avoid the 10% penalty if you are under 59 1/2. If you’re over 59 1/2, you can take money out, and it is reported as ordinary income for tax purposes.
20% Withholding
If you take a cash distribution from your former spouse’s plan rather than rolling the funds over into your own retirement account, the plan is required by federal law to withhold 20% of the amount you receive for federal income taxes. This is similar to having federal income tax withheld from your paycheck. You will be able to claim the amount withheld on your income tax return when you file it the year following the payment.
Note to Divorce Mediators and Attorneys:
Many of you may be a little hesitant about explaining the tax aspects of QDROs to your clients. Among the excuses given are “I can’t give tax advice.” Or “You really should talk to your accountant.” For most situations, you can provide this tax information safely. But if you have any questions about the tax aspects of QDRO, please contact me at 845-638-4666.
Steven L. Abel, Esq.
101 South Broadway
Nyack, NY 10960
(P) 845-638-4666
(E) [email protected]
