We all know that if you take money out of a retirement plan before the age of 59 1/2 you will have to pay state and federal income taxes and a 10% penalty. But, there is a special loophole in divorce.
If you or someone you know is going through a divorce, it is imperative to know what 72(t)(2)(c) is. This is the tax code during the divorce process that allows someone going to receive assets from their spouse’s 401(k) plan as cash and escape the 10% penalty even if they are under the age of 59 1/2. They will still have to pay state and federal income taxes on the money, but will not have to pay the 10% penalty.
An example of how this works is when let’s say Bill has $500,000 in a 401(k) plan and Judy will be receiving $300,00 from his 401(k) as part of the divorce, but she needs $50,000 of liquid money now. So, when the QDRO is written (the legal document needed to divide a 401(k) as part of a divorce) Judy can take $50,000 as a cash distribution and the $250,000 left can be rolled into an IRA Rollover. On the $50,000, Judy will have to pay state and federal income taxes, but can escape the under age 59 1/2 10% penalty for she is taking this money out as part of the divorce.
This is one way spouses can get liquid money if there is no better option out of the divorce. This is not a save all but definitely an option to know about. This only works on 401(k) plans that are of your spouse (or soon to be ex). This does not work on IRA’s. So if you or someone you know is going through a divorce make sure the 72(t)(2)(c) is understood. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Securities offered through LPL Financial. Member FINRA/SIPC.Tagged with: divorce • retirement plan and divorce • tax advice • tax code • tax code during divorce process