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Avoiding taxes and penalties when dividing retirement accounts

California couples who are getting a divorce may want to keep things as simple as possible, but if they are splitting a retirement account, they might need professional assistance to avoid having to pay taxes and penalties. For example, to split a 401(k), the couple will need a document known as a qualified domestic relations order to avoid these costs.

In one divorce, the higher-earning spouse withdrew $250,000 from a 401(k). The couple did not have a QDRO, and the tax on the withdrawal was $85,000 while the penalty for taking an early distribution was $25,000. The QDRO is a complex document that must be prepared correctly, and errors can cost hundreds or thousands of dollars. Therefore, people who are divorcing may want to work with someone who has experience with QDROs.

Another issue with splitting retirement accounts is that pension plans often come with their own set of rules that must be followed in order to avoid taxes or penalties. Failing to complete the paperwork before a divorce is final might also cause problems. For example, one person died without signing the QDRO but after the divorce. Because the QDRO was incomplete, the former spouse did not receive any part of the pension. Some couples might decide to make a different kind of exchange instead of splitting the retirement account.

California is a community property state, and while in general this means that marital assets are supposed to be split 50/50, there may still be room for a couple to make other choices. One person might decide to relinquish half of the retirement account in exchange for another piece of property. In a high-asset divorce, there may be a number of items to split such as investment accounts and real estate, but people should make sure they understand the full value of those assets as well as any future income tax consequences.

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Miller & Associates, Attorneys LLP

Miller & Associates, Attorneys LLP
6542 Lonetree Boulevard
Rocklin, CA 95765

Phone: 916-780-0848 
Fax: 916-780-0787

Miller & Associates, Attorneys LLP
850 Iron Point Road, Suite 113A
Folsom, CA 95630

Phone: 916-365-4941 
Fax: 916-780-0787

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