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A Tip That Can Save You Thousands: Dividing a 401-K in a Divorce

Finding BalanceDid you know that if you are divorced and are the recipient of all or part of your former spouse’s 401-K, you may have an opportunity to take cash out of the account without paying the IRS’s 10% penalty (on funds withdrawn prior to age 59.5)? To be clear, that is one opportunity (barring any other financial hardship). To take advantage of this, when dividing a 401-K in a divorce, have the portion you need paid directly from the account to you. It does not need to be the full amount that you are receiving. You do not want to roll it into an IRA and then take it out because then you will be subject to the penalty. 


Am I suggesting that retirement plans are a good source of cash when going through divorce? Let me be clear. No, I am not suggesting that at all. I simply want to share that if you have a cash need and it makes the most sense to take it from a retirement account, the IRS does give you an opportunity to take money without penalty. Keep in mind, though, if the funds are in a pre-tax account, they will still be taxable when withdrawn. The plan administrator will withhold taxes when the distribution is made. However, it may not be enough to cover your tax liability, depending on your marginal tax rate, so you’ll want to plan accordingly.


It is best to consult with your financial advisor and/or tax professional to determine the best source of cash for your individual situation, especially when considering taking an early withdraw from a retirement account. Unfortunately, some professionals may not be familiar with this rule, which is one of the benefits of working with a CDFA (Certified Divorce Financial Analyst), who has specialized training in dealing with financial planning, specifically related to divorce.


For questions or assistance with accessing the best source of cash for your particular situation, schedule a no-cost consultation.


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