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Are taxes and penalties a risk when dividing 401(k)s in divorce?

On Behalf of | Jun 4, 2024 | Property Division |

Spouses preparing for divorce typically need to put together lists of their marital resources. They use those inventories of assets and debts as a starting point for property division negotiations. Often, certain resources are harder for couples to address in a way that they both agree is appropriate and fair.

Retirement accounts are often among the most valuable assets people have accumulated during marriages. Retired adults depend almost exclusively on their retirement savings and may therefore be anxious about the idea of dividing those savings when they divorce. Accounting for retirement savings set aside during the marriage is necessary for most couples dividing assets in a divorce.

Do people also have to worry about taxes and penalties further diminishing their retirement savings during a divorce?

Penalties are largely preventable

Most of the time, deposits made into retirement accounts are marital property that people must divide when they divorce. Even though the account may be in the name of one spouse, both spouses have an interest in the balance accrued during the marriage.

Although people may not be able to prevent the division of a retirement account during divorce proceedings, they can at least avoid the penalties and tax consequences of early account withdrawals. If someone has a 401(k), for example, substantial withdrawals from the account would increase their annual taxable income.

The withdrawals made from the retirement account could substantially increase income tax obligations the year that someone removes the funds. Additionally, a penalty could be due. It is common for people to face a 10% penalty for any early withdrawal.

If actually splitting the account is the chosen solution for a 401(k) in the divorce, spouses can use a qualified domestic relations order (QDRO). This special document, when properly filed, can eliminate the tax and early withdrawal penalties that pulling funds from the account might otherwise generate.

Many people would prefer to find alternate solutions rather than actually dividing the retirement account itself. The extent of the marital estate and a host of other factors influence the best solution for complex property division matters.

More assets and a more complex marital estate mean more opportunities to be creative about dividing property fairly without splitting specific assets, like retirement accounts. Knowing what to expect when handling complex assets can help people pursue a reasonable division of their marital assets when they divorce.