QDRO splits and avoiding 10% penalty

[mbxdad]

Earlier posts on this forum delved into QDROs as the way to split 401k assets, but didn't really say how to do the split, nor how to avoid the penalty.

In my situation, STBX would like to put some money into a 401k (or IRA), and some into a house down payment.

Two questions:

1. How do you specify the split? Is that done as part of the QDRO itself, or is the money first transferred into a 401k/IRA and then the house down payment money withdrawn?

2. How is this done in a way that avoids the 10% penalty for early withdrawals?

Fidelity has a tool to generate the QDRO for you, but I haven't come across provisions or documentation on how to do a split.

Thanks! (yes, I know this is 'not my problem', but STBX is playing nice so far and it's in my best interest...)

[hoosier_dad]

1 - The QDRO specifies the details of how the account is split and where to deposit your ex's share. The company managing your 401k will handle all the transfer details based on the QDRO order signed by the judge. Keep in mind that the QDRO has to meet the requirements of the company managing the 401k and at least in my process they reviewed and approved the QDRO before it was submitted to the judge to sign.

2 - Don't know if that is possible other than a hardship withdrawal.

Keep in mind that the QDRO is something that is normally done after the divorce is finalized, so the decree should list the way the 401k will be split and how the QDRO will be handled, but the withdrawal options and possible 10% penalty should not be part of the decree, that is something your ex needs to figure out on her own.

[minuette]

The basic order of things in your case should be:

1) Spouse rolls her portion of the retirement funds into an existing 401(k) or new/existing IRA per the QDRO (this is a tax-free transaction);

2) Spouse then completes whatever forms are required by the financial institution managing her new IRA to get a distribution for the purchase of a home (20% of the distribution will probably be sent to the IRS by the financial institution for federal tax withholding);

3) If spouse qualifies for favorable tax treatment of the early distribution (i.e., first-time homebuyer exemption from penalty), fine. If not, 10% penalty applies.

Of particular interest to your spouse is IRS Pub 504 and 590.

First home. Even if you are under age 59½, you do not have to pay the 10% additional tax on up to $10,000 of distributions you receive to buy, build, or rebuild a first home. To qualify for treatment as a first-time homebuyer distribution, the distribution must meet all the following requirements.

It must be used to pay qualified acquisition costs (defined later) before the close of the 120th day after the day you received it.
It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer (defined later) who is any of the following: yourself, your spouse, your or your spouse's child, your or your spouse's grandchild, your or your spouse's parent or other ancestor.
When added to all your prior qualified first-time homebuyer distributions, if any, total qualifying distributions cannot be more than $10,000.

Qualified acquisition costs. Qualified acquisition costs include the following items.

Costs of buying, building, or rebuilding a home.
Any usual or reasonable settlement, financing, or other closing costs.

First-time homebuyer. Generally, you are a first-time homebuyer if you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.

[mbxdad]

Thanks hoosier and Minuette - you pointed me in the right direction.

After quite a bit of digging into our 401k plan and talking to the plan administrators, here is what I learned. This works for my particular plan (administered by Fidelity) but may not work in all cases.

1. QDRO submitted to court as part of divorce filing
2. Judge signs off on QDRO
3. QDRO submitted to 401k plan administrator
4. 1 week review process
5. A temporary account is created for STBX. Lasts for 45 days.
6. STBX's funds are separated from mine and placed into her (temporary) account
7. She can do one of the following, none of which will incur the 10% penalty:
a. rollover funds to an IRA (or other 401k, but that doesn't apply for us)
b. take out a cash distribution. Taxes are withheld from this, but no penalties.
c. A mix of (a) and (b)

For monies which are rolled over to an IRA, the normal early withdrawal penalties apply (per Minuette's comments and quotes).

Bottom line is that there is a short window of opportunity to take cash out without penalty, but it must before any rollovers into the IRA.

Tricky!! And not well documented anywhere.

[mbxdad]

Just thought I'd mention that Fidelity told me the QDRO could take 8-10 weeks before funds were available. However it looks like it will be more like 3 weeks (yeah!)

[anonymous guest]

Yes, she can take out the $ right after the divorce and avoid the 10% penalty, just has to pay taxes as per normal income. This works if she isn't working and doesn't take out too much.

What you need to avoid is paying taxes or penalties, so stick to your guns about transferring 401K to 401K/IRA.

[mbxdad]

A bit of a warning to anyone who will need to do a QDRO cash-out:

The ex got paperwork saying that her temporary 401k has been created and was ready for her to do with as she pleased.

She visited the Fidelity office to get her money, and received bad advice from the Fidelity rep. She wanted to take out money to buy a house, and transfer the remainder into an IRA (and this is the order you need to do it in order to avoid the 10% penalty on the amount withdrawn - you need to take the money out before it lands in the IRA). Instead, the Fidelity rep told her - incorrectly - that her only option was to transfer the money into the IRA, and then take out the money for the house (this will force a 10% penalty on money withdrawn from the IRA!).

I caught the error within the hour, but it was too late for Fidelity to reverse the transaction. They now require her to go through a formal / written complaint process, and even then there are no guarantees that they will agree to reverse the transaction (in which case there will be a formal FINRA complaint and a lawsuit against them - including punitive damages, as this has been a major hassle). Net - lots of headache and a delay in her getting the money to buy the house she'll move into when she finally leaves (now) my house.

Ignorance runs rampant in the industry on this topic! You MUST gain the knowledge yourself - or your NJ needs to. The Fidelity rep was ignorant of the process on how to withdraw cash without incurring the penalty. Two tax accountants I talked to were also ignorant about this part of the IRS code.

The relevant IRS code is IRC 72(t)(2)(c).

LESSON: TREAT THIS PART OF THE TRANSACTION WITH KID GLOVES.

[thetall1]

Is this info. still accurate (no changes in laws or just specific to some 401k's)? I'm looking into a way to avoid SS with a cash settlement. I'd really like to offer up some of my 401k to her as a lump sum in order to avoid any sniff of alimony. If I can find a way to do so without the 10% penalty I think it would increase my chances.

mbxdad if you're still around and this has been over a year, can you post on whether everything regarding your post on avoiding the 10% penalty worked out for you?

[secondhalf]

I have 50% of my ex's 401K. I have occassionally withdrawn from that account and I am less than 59.5 years old. No 10% penalty has applied (an exception is noted on the tax forms). Have questioned the 401K administrators on this issue and they have told me that is correct, no penalty. Therefore, I must assume that it depends upon the 401K and/or how the QDRO is drawn up.

[mbxdad]

Is this info. still accurate (no changes in laws or just specific to some 401k's)? I'm looking into a way to avoid SS with a cash settlement. I'd really like to offer up some of my 401k to her as a lump sum in order to avoid any sniff of alimony. If I can find a way to do so without the 10% penalty I think it would increase my chances.

mbxdad if you're still around and this has been over a year, can you post on whether everything regarding your post on avoiding the 10% penalty worked out for you?

I"m still around. As my previous post mentioned, the NJ screwed it up, otherwise she could have avoided the 10% penalty (I am positive of the ability to avoid the penalty). But she screwed it up, Fidelity refused to reverse it, and the NJ ended up paying a boatload of penalties.

She is still very P.O.'d at me for her mistake.