Today we hear from Karen in PA who tells us, “ I just got divorced. I am entitled to $40,000 of hubby’s 401(k). I’m permanently disabled and haven’t worked since 2003. I need this money for necessities, but don’t want to pay early withdrawal or tax penalties.
Because I’m disabled and receive a pittance from Social Security – and have huge medical bills, including Gap insurance, would I be exempt from these penalties?”
Well, it’s nice to see your husband standing by you in sickness and in health.
Did your attorney arrange for a court-ordered QDRO (Qualified Domestic Relations Order) to transfer the money from your husband’s account to you? It can be part of your divorce decree rather than a separate document. Ask your attorney.
You can read about QDROs here on the Department of Labor’s website. https://www.dol.gov/ebsa/faqs/faq_qdro.html
If there’s a QDRO, you can roll over all the money to your own retirement account, tax-free. That means, he won’t pay tax or penalty on the withdrawal – and neither will you on the rollover.
If you need money to pay this year’s bills, split that roll-over.
Draw the money you need this year – and roll over the rest.
That way, you’ll pay taxes on the money you draw, but no penalties. In fact, with your medical bills and all, you may get away with no taxes at all. You can play around with the TurboTax Estimator to see the optimum amount to draw to avoid taxes each year.
When you draw the money in the future, instruct the trustee of the account to use Code 3 on the withdrawals – that means permanent disability. You’ll still pay taxes on the money you use – but no early withdrawal penalties.
(See page 7 of the 1099-R forms package.) https://www.irs.gov/pub/irs-pdf/f1099r.pdf
Incidentally, if there’s no QDRO, just an overall split of the marital assets, your ex will pay taxes on that withdrawal, as well as an early withdrawal penalty. I hope his attorney took better care of him than that!
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But in that case, you’d get the money free and clear and can just deposit it into your savings account without any tax consequence. I do hope this helps.
And remember, you can find answers to all kinds of questions about divorce and all kinds of other tax issues, free.
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Where? Where else? At TaxMama.com
- Ask TaxMama :: Where taxes are fun and answers are free
- TaxQuips :: The number ONE tax podcast online
- Department of Labor FAQs :: QDROs (Qualified Domestic Relations Order)
- TurboTax Site’s :: Tax Estimator
- IRS Form 1099-R :: Distributions From Pensions, Annuities, Retirement or…