401K and Divorce – What Are The Rules?
The state where divorcing couples reside will determine the property allocation laws and joint marital property. Many states’ legislation allows ex-spouses to keep property they used to own before their marriage, but after marriage any jointly owned accounts are divided under set rules. This includes 401k accounts that list the spouse as beneficiary. Distributions from 401K and divorce requirements can be taxed according to early withdrawal rules and penalties.
– Most states follow the common law impartial distribution rule, and judges generally distribute marital properties equally between the divorcing spouses. It is a rule that each spouse will keep ownership of the amount of funds in their retirement pensions and solo 401k plans earned preceding their marriage. The remaining amounts are generally considered common marital property and subject to equal allocation. State laws can also allow judges to divide properties to fit the interests of fairness. If a judge determines marital fault or economic hardship conditions, property can be awarded exclusively to one or another spouse. This includes 401k accounts.
– The Internal Revenue Service rules state that 401K accounts are subject to taxation when an amount is withdrawn from the account before legal retirement age. The IRS additionally assesses a 10 percent tax penalty for removing funds prematurely. Recipients who withdraw their funds before reaching 59 ½ are exempt from the 10 percent penalty if they can show financial hardship, the 401k plan ends, employments terminates and in the event of a qualified divorce decree. In other words 401K and divorce can exempt the 10 percent penalty.
– The Employee Retirement Income Security Act is a federal law or act that regulates retirement accounts and determines the 10 percent penalty. In avoidance of the penalty, spouses must present a valid divorce order allowing them to withdraw their share of 401K benefits. This federal law allows divorcing spouses access to funds without incurring a penalty only if proper documentation is provided. However, divided couples are subject to regular taxation on withdrawals, based on their individual tax proportions. 401K plan withdrawals are considered income. The penalty can also be avoided by rolling the funds over into a replacement 401k plan. 401K and divorce papers need to include specific distribution requirements.
– There must be a qualified domestic relations order decreed by the court that determines who owns 401K assets. Without the order from the courts the original owner of the 401K account keeps full ownership of the account’s assets. 401K and divorce orders through the domestic relations paper can exempt the 10 percent rule if it is explicitly stated. The names of the alternate payees, distribution percentages and division at a later date need to be included in the court order.
To take advantage of retirement cash flow, consider a 401K either though your employer or solo. There are tax advantages, employer matching programs, portability and loan and hardship withdrawal provisions. Early retirement planning can give you an edge when retiring and despite the hardship of 401K and divorce will provide couples with retirement security.