Penalties for a 401(k) in a Divorce Settlement

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401(k)s and other retirement savings earned during a marriage are considered communal or marital property in most states. At divorce, each spouse is entitled to a portion of any 401(k) earned, including those earned by the other spouse. Depending how the 401(k) is split, and if there is a payout at divorce, the Internal Revenue Service may assess a tax penalty.

Property Distribution

  • At divorce, all property accumulated during the marriage is divided between the spouses. In community property states, such as California, all marital property is divided equally, 50/50. In equitable distribution states, such as New York, marital property is divided by what is fair and reasonable based on each party's personal finances and other considerations. The majority of U.S. states practice equitable distribution.

    Retirement plans, such as 401(k)s, earned during the marriage are also divided. When a spouse is awarded a portion of the other spouse's 401(k) benefits, tax penalties may be assessed, but not always.

Tax Penalties

  • The IRS attaches a 10 percent penalty for early distribution of a retirement plan. If a spouse is awarded a portion of the other spouse's retirement benefits and elects to withdraw the money at that time, the amount will be taxed as regular income with an additional 10 percent penalty. However, alternate payees have a one-time opportunity to take out their 401(k) money penalty-free at divorce. The money is still taxed as income.

Alternatives

  • A spouse can elect to receive the funds later, as they were originally intended to be paid out. In this instance, the funds will be paid at a later date in accordance with the terms of the original 401(k) plan. The future funds will be paid through a qualified domestic-relations order, or QDRO, and no tax penalties will be assessed.

References

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