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401K penalties, taxes and your divorce

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August 8, 2020

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401K penalties, taxes and your divorce

One type of asset many couples must share when getting a divorce is their retirement savings. When one spouse’s 401K account must be split with the other party, the account holder should understand the logistics surrounding a withdrawal for this purpose.

Retirement funds like 401K accounts target providing an income stream for people once they quit working. For this reason, any distributions from such an account prior to that time may result in additional fees and penalties. A qualified domestic relations order may avoid this scenario.

How a QDRO works

The United States Department of Labor explains that a QDRO works in some essential ways. First, it allows the account owner’s spouse to be named as an authorized payee on the 401K. This enables the payment of distributions directly to that person, preventing the account owner from paying any early withdrawal fees. The qualified domestic relations order receives approval from the plan administrator and the court, preventing the assessment of penalties on the authorized payee as well.

Tax responsibility under a QDRO

Because a 401K account is funded with pretax dollars, any distribution from this type of account may be subject to taxation at the time. According to the Internal Revenue Service, however, the authorized payee may postpone the payment of taxes by putting any money received into another qualified retirement account upon receipt. Taxes may then be owed when the person eventually withdraws funds from that new account. The QDRO also shifts the income tax liability for money received per the order from the account owner to the authorized payee.

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