I will be receiving monies from a QDRO executed pursuant to my divorce. I would like to take a portion of the money as a distribution to pay for a new home. What are the tax implications of doing this?

By Denise Appleby AAA
A:

There are several issues to consider:

  • The early distribution penalty - Assets distributed from a qualified plan in accordance with a qualified domestic relations order (QDRO) are exempted from the 10% early-distribution penalty. If you will be using any portion of the assets immediately, it may be practical not to roll over that portion of the assets to an IRA. If you are under age 59.5, amounts rolled over to a Traditional IRA and later distributed from the IRA will be subject to the 10% early-distribution penalty, unless you meet an exception.

    You could have a portion of the amount processed as a direct rollover to your Traditional IRA and the balance paid to you. The amount that is processed as a direct rollover to your IRA will not be subject to tax withholding.

  • Tax Withholding - Because the qualified plan assets you receive pursuant to a QDRO are rollover eligible, amounts that are paid directly to you instead of to an eligible retirement plan through a direct rollover will be subject to mandatory withholding. This withholding is 20% for federal taxes and, depending on your state of residence, the payor may also withhold amounts for state taxes. Therefore, you may need to increase the distribution amount to ensure that the net amount you receive is sufficient to meet your immediate financial needs.
  • Distributions may be taken over a certain period - Unless you need to distribute some of the assets immediately, you may choose to roll over the assets to your Traditional IRA and have the distributions paid to you over time (from the IRA). Amounts paid to you for at least five years or until you are age 59.5 (whichever is longer) are exempted from the 10% early-distribution penalty, provided the payments meet certain requirements. This is commonly referred to as substantially equal periodic payments or 72(t) distributions. If you decide to consider this option, you'll need to know the amount you would receive each year and decide whether this amount meets your requirements.
  • Converting the asset to a Roth IRA - If you want to convert the assets to a Roth IRA, you must first roll the amount to a Traditional IRA. The amount may then be converted from the Traditional IRA to your Roth IRA. You will owe taxes on the converted amount for the year the conversion occurs.
  • Caution - Some qualified plans will not distribute assets pursuant to a QDRO until the plan participant, in this case your former spouse, experiences a triggering event, such as reaching retirement age or being separated from service with an employer. Other plans consider a QDRO a triggering event. Check with the plan regarding its rules for processing distributions due to a QDRO.

This question was answered by Denise Appleby
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