Distributions from Retirement Plans

Divorce proceedings can be emotionally challenging and digital missteps can create unnecessary complications.  Improper use of drones, remote access to a computer and use of nanny cams, hidden recording devices, air tags, and other modern technologies have become significant concerns in divorce cases. 

Emotions rise during divorce, and spouses sometimes resort to digital surveillance of their future ex spouse whether or not they engaged in this activity prior to filing for divorce.

Appellate case law has opined on some of these cases, issuing restraining orders for drones flying over the spouse’s house or remote access to home computers or networks such as digital light switches, cameras, and smart thermostats. With the technology advancements, domestic issues have arisen as future ex-spouses are victims of Facebook logins, bank account invasions and other laptop intrusions.   

Accessing another party’s accounts can raise serious legal and ethical concerns.  It may involve issues related to privacy, confidentiality, and attorney-client privilege.  In some situations it can even violate computer access or privacy laws. 

More importantly, information obtained this way could end up damaging one’s case or limit how an attorney can use certain evidence. 

There are practical steps for the targeted spouse to ensure privacy.  Most immediately, change alarm codes and locks in the home to avoid the out spouse from showing up and walking in unannounced. Even if that spouse has the right to enter the home during the separation and divorce process, these extra security provisions set boundaries on when and require both parties to set a mutually agreeable time

If you have access to the security system account, either contact the surveillance and security system company directly to change your account information or simply log into your account and change the account information yourself, including any usernames, emails, and passwords.  New account information that is unknown and cannot be guessed by your ex is critical.

Remove the batteries or remove certain systems altogether by taking down all cameras and/or audio recording devices from outside and inside of your home and disabling them. 

Not doing anything means you could remain under a surveillance microscope, including surveillance footage and audio recordings.  A future ex could still have access and may attempt to use this information to their advantage during the divorce process or to harass the other spouse. It is important to maintain privacy and ensure that the everything is kept confidential. Equally important is to be stress-free from harassment.

Note:  This article is for informational purposes only and is not intended to provide either tax or legal advice.  Please contact your attorney or accountant and rely on their independent research and advice for these matters.

 Normally, distributions from retirement plans before attaining age 59 ½ come with a 10% penalty tax in addition to the ordinary income tax rate on the distributed amount. The penalty tax does not apply if the distribution from an ERISA retirement plan (qualified plan) is made incident to divorce, upon death or disability for the life expectancy of the owner of the plan or distributions made via Qualified Domestic Relations Order (QDRO) for the ex-spouse (alternate payee) in the case of divorce.

This special consideration for waiver of penalty for an early distribution if the ex-spouse is not 59 ½ years old, is provided for under Tax Reg. (72)(t)(2)( C).  This regulation expressly states that when funds are withdrawn in accordance with a written divorce instrument (QDRO), the recipient (alternate payee not the owner of the plan) will have the penalty waived.

Frequently in divorce matters, the owner wants to withdraw with the same waiver of penalty. This is not allowed. The funds must first transfer to the alternate payee who then can withdraw the funds without incurring the penalty (although ordinary taxes will still apply). 

Because ordinary taxes apply, the funds is required by law to withhold 20% of the withdrawn amount to apply to federal taxes.  The alternate payee should ensure that enough is requested to have sufficient funds after accounting for the 20% that will be withheld and for any additional taxes that may be due on the withdrawn funs.  Oftentimes, depending upon the tax bracket and other considerations at tax time, there may be an additional amount due for ordinary taxes for both federal and state returns.  It is imperative to withdraw sufficient funds to cover the liability of federal and state taxes beyond the 20% automatically withheld by all Plans, if other sources of funds are not available to pay taxes. 

The Plan itself guides the cadence of the withdrawal, not the ERISA law.  The Plan may determine that a one-time distribution may be taken only. Or, the Plan may allow as many withdrawals from the alternate payee’s account once the retirement account has been segregated.  It is not negotiable but rather a stipulation of the Plan itself. The Marital Settlement Agreement cannot override the Plan. The court ordered approved QDRO cannot override the Plan rules either.  The Plan has the ultimate control over the frequency of withdrawals.

Also, the Plan may stipulate that the funds must be withdrawn ONLY at the time of segregation. That is, the alternate payee, through the drafting of the QDRO, requests an amount to be withdrawn and the remainder to be segregated to an account in the alternate payee’s name.  Once this withdrawal takes place, there is no other opportunity for a penalty-free withdrawal if the alternate payee needs additional funds in the future and is still younger than 59 ½ years old. 

If the alternate payee chooses not to take the funds at the time of segregation by specifying it in the QDRO, and later rolls the account into a rollover IRA, there is no opportunity to withdraw funds.

IRAs are not considered a qualified plan. The alternate payee is held to the early withdrawal rule and if they withdraw from the IRA afterwards, they will pay both the 10% penalty and the taxes due on those funds.

It is important to understand the difference between rolling over money from a qualified plan and transferring money from a qualified plan.  The alternate payee may not wish to retain their new account at their spouse’s former employer, and instead wish to rollover to an IRA. If this is the case, the funds must be sent directly from custodian to custodian to avoid the rollover being considered a withdrawal.  Otherwise, if sent directly to the participant, the funds will be subject to the 20% withholding.  Only a direct transfer avoids the withholding tax.

The withdrawal of funds may be necessary in divorce cases for the payment of attorney’s fee, down payment on a new house or for various other reasons.  It is important to understand the tax implications of these withdrawals and to ensure that the transfer of funds is within the parameters of the law. 

While it is not always prudent to withdraw funds that were intended for retirement purposes, this is a great planning tool when a divorcing party who will receive the funds from a qualified retirement plan have a need for cash and there is no other alternative.

This article does NOT constitute tax or legal advice and is for general information purposes ONLY. Prior to making any decisions, seek legal counsel from a licensed attorney and CPA.