At Beller & Bustamante, we know how daunting the process of divorce can be and the toll it can take on you and your financial well-being. Securing separate residences, paying down debt, caring for children, and paying attorneys’ fees adds up quickly. Most individuals have a difficult time managing assets to ensure each of these needs are met adequately and on time. In some cases, it is enticing to pull from your hard-earned assets sitting idle in your retirement funds. However, before making a move to withdraw money from a 401(k), TSP or IRA, it is necessary to know the limitations and implications of withdrawals during the divorce process.
Understand Your Withdrawal Limitations
Under law, retirement accounts (including employer-sponsored plans, such as a 401(k) or 403(b)) and individual IRAs bear certain restrictions that do not allow for withdrawals before the age of 59 1/2 without penalty. Distributions from your retirement funds outside the circumstances of an exempt life event or before the qualifying age may result in a 10% tax penalty, and the total withdrawal amount is added to ordinary income tax calculations. While it may seem as though retirement funds are a simple solution to the financial burdens that can come with a divorce, being unaware of these penalties can be detrimental to your financial well-being.
In addition to taking early withdrawals to pay expenses, taking a distribution from your retirement account in preparation of a divorce is viewed negatively by the courts. During your divorce process, a judge may see a distribution as an attempt to hide assets from a spouse and the court, which could have an even greater impact on your financial situation. Similarly, removing funds from a retirement account as an advance on your share of marital assets can mean other monies will be due to your spouse as a form of reimbursement.
While the penalties on early distribution of retirement funds are a deterrent to making a withdrawal, there are certain circumstances surrounding a distribution that are allowed during the divorce process. In some cases, drawing down retirement assets as a means to pay down marital debt such as credit cards or personal loans may be qualified as a penalty-free distribution. Similarly, using retirement funds to keep marital property such as a vehicle from being repossessed may also be exempt from penalties. Also, retirement assets may be used in some instances to cover child or spousal support payments that are not being made by a spouse. While each of these circumstances fall under the purview of financial hardship and may be exempt from penalties, taxes may still be assessed on distributions.
Withdrawing retirement funds to pay for the costs associated with the divorce process may not be the only time distributions are warranted. Oftentimes, a divorce settlement includes equitable distribution of marital assets, including some or all of accumulated retirement funds. As an alternative to paying assets to a spouse through a direct withdrawal of retirement funds, a qualified domestic relations order – also known as a QDRO – is implemented. Withdrawals that do not fall within the exempt categories of financial hardship listed above result in penalties that could drastically reduce the value of your assets. A QDRO, however, allows for a penalty- and tax-free transfer of retirement funds to your spouse as the result of a divorce settlement.
Speak with Knowledgeable Family Law Attorneys in Florida
At Beller & Bustamante, we know how challenging it is to fully understand each of your options throughout the divorce process. We work diligently for our clients to ensure they are making the best decisions for themselves and their families before, during, and after a divorce. If you have questions about your rights as a spouse, contact our experienced attorneys today.