Distribution Exception Code - Qualified Retirement Plan

[catax]

I am looking at exception code 06 72(t)(2)(C ). I have a client that is divorcing and receiving a distribution from her husbands 401K via a Qualified Domestic Relations Order. I had understood that this exception code was for the spouse making the distribution from the retirement plan, but that the distribution had to stay in a rollover IRA when paid over to the other ex spouse. I didn't understand that the money could be distributed completely by the spouse required to make the payment and avoid the penalty. However, after reviewing this I am rethinking this issue because of how the other exception codes work. Can you help clarify this issue for me? To avoid the penalty does the money have to stay in a qualified account in the other ex spouses name or can it be actually distributed from the qualified account and avoid a penalty? Thanks, Nena

[taxtrio]

The exception for the QDRO (qualifed domestic relations order) eliminates the 10 percent penalty. It doesn't matter if the receiver of the distribution rolls it over or keeps it or spends it.. whatever.

Two separate issues. If recipient keeps money (no roll over) then tax to be paid. If rolled over then tax is deferred until withdrawn from IRA..

The 1099R will be issued in the name of the the recipient.

For example: Husband has 401k, court orders that wife gets 1/2 of 401k in divorce.

QDRO is sent to 401k plan, they distributed to the WIFE in WIFE's name, she has the tax consequences. He pays no tax.

I've seen soon-to-be ex-husbands make a big mistake--- and go and take the w/d themselves and write a check to soon-to-be ex-wife---OOOPS--- He gets the 1099R and he pays the tax AND THE PENALTY!! OUCH!

P.S.

[kcjenkins]

The spouse who owned the 401K gets the exception, and so does the spouse who gets the money. But only for the early withdrawal penalty. If that spouse puts it into an IRA then it is not taxed to her at that time. But if she instead just takes the cash and puts it in her bank account, or spends it, she will owe tax on it, just no penalty.

[catax]

Thank you. One more question. The spouse that makes the distribution under the QDRO would not pay the tax? The spouse that receives the distribution would owe the tax? This situation is somewhat strange because the distribution is being made from the 401k to replace nonqualified money that the spouse took out of the joint bank account and spent when he left. So the spouse receiving the distribution is just trying to get themself back where they started. That never happens does it? Anyway clarification on the tax part of this would be helpful, thanks. Nena

[catax]

Scratch that question. I missed taxtrios post and that clears it all up for me. Thanks again both of you for your responses. Nena

[Amy (biznester)]

Thank you. One more question. The spouse that makes the distribution under the QDRO would not pay the tax? The spouse that receives the distribution would owe the tax? This situation is somewhat strange because the distribution is being made from the 401k to replace nonqualified money that the spouse took out of the joint bank account and spent when he left. So the spouse receiving the distribution is just trying to get themself back where they started. That never happens does it? Anyway clarification on the tax part of this would be helpful, thanks. Nena

Nena, is the divorce finalized yet? Because, if it wasn't (AND she's not going to roll it into her own IRA), I'd urge my client to go to her attorneys and demand that the husband get the distribution 1099'd to him, then write her a check, so that he will be responsible for the taxes. Either that or he has to reimburse her for the regular tax she owes on the distribution, in addition to the distribution. Since you have disclosed that's she is getting the distribution to reimburse her for the checking account money, she is going to lose out by the amount equal to the tax. If it were me, I'd be calling that a "fast one" being pulled by the husband's legal team.

Having been intimately involved with two friends' divorces, I would be willing to bet money that the husband's divorce attorney told him to drain that account first thing, because I've seen two divorcing men do that and one of them even bragged about the attorney telling him to do it. And the friends' attorneys sat there and sang, la di da. Just sayin....

[zeke]

"Having been intimately involved with two friends' divorces, I would be willing to bet money that the husband's divorce attorney told him to drain that account first thing, because I've seen two divorcing men do that and one of them even bragged about the attorney telling him to do it. And the friends' attorneys sat there and sang, la di da. Just sayin.... "

Amy - All true. I have also seen the wife do the same thing.... ;)

[BulldogTom]

Amy,

I like your other avatar better.

Tom

Lodi, CA

[Amy (biznester)]

Definitely, Zeke. Did not mean to imply that was only a husband's trick.

Thank you, Tom. I sold it though, for big bucks on ebay. Apparently there's a big market out there with the dairy farmers....

Okay. Not really. ;-)