August 20, 2008 (18:00)  The QDRO distribution: avoiding the 10% early withdrawal penalty

Most people know that a QDRO allows for a tax-free transfer of a retirement plan between spouses in a divorce. What most people don't know (including most CPAs and financial planners that do not specialize in divorce) is that the receiving spouse can take a distribution from the QDRO'd retirement plan without incurring the 10% early withdrawal tax penalty. Why would they do this if they still have to pay taxes? A client would do this for numerous reasons. What if the client needs to refinance the marital home and doesn’t have cash available? What if the client has charge card debt and attorney’s fees to pay? Where will the money come from? The money would have to come from the retirement plan if there are no other liquid assets available. If the interest rates on charge cards are higher than the tax bracket of the client, then it would make sense to take a distribution without the penalty and payoff the debt.

How is this type of distribution done? It is done under IRC 72(t)(2)(c). The IRS allows for a distribution from an ERISA covered retirement plan under a QDRO without incurring a 10% penalty pursuant to a divorce. Although the distribution will be taxed as ordinary income, avoiding the 10% penalty can be very useful in post-divorce financial planning. However, taking advantage of this exception can be tricky.

A distribution under this rule can only be done from an ERISA covered retirement plan that has been QDRO’d. This rule does not apply to IRA distributions. Therefore, if a client QDROs their awarded benefits, rolls it into an IRA and then takes a distribution, the 10% penalty will apply to the distribution. The client has to take the distribution prior to a rollover into an IRA to be exempt from the 10% penalty.

Care needs to be taken when doing this type of distribution. Most companies have separate departments that process each request. Therefore, a rollover request could be sent to one department and a withdrawal request to another. Therefore, if the rollover department processes the rollover request first, the client could possibly lose their penalty-free distribution.

This is why the consultants at QDRO Direct, LLC offers clients a free distribution consultation as part of the QDRO fee. It is important that the clients know they have this option. The distribution consultation offers your clients the ability to see how the distribution will affect their tax liability, potential future savings and whether a distribution is in their best interest. Call our office if you would like to have a QDRO distribution analysis done prior to settlement.

QDRO direct, LLC
QDRO and Pension Consultants
370 Camino Gardens Blvd. Suite 344, Boca Raton, FL 33432
Toll: (888) 474-7376
Ofc: (561) 394-2337
Fax: (561) 394-2197
info@qdrodirect.com
www.qdrodirect.com

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