Can a divorced parent rollover their 401(k) into their child's 529 plan without incurring a penalty?
Is it possible and sensible to rollover my 401(k) from a former employer (approximately $36,000) to a 529 plan for my son? I am 48 years old. My ex received $50,000 out of my 401(k) when we divorced. I know I would get taxed, but I heard I could do this with zero penalty if I was divorced. Is this correct information?
I believe that you may have misheard. If it is your plan, even though you are divorced, you would still be subject to the 10% penalty if under the age of 55. Together with the tax and penalty, you may have as little as 45 percent left. Without detailed calculations, I am not sure that it would be worthwhile to make that change and then you would still be short at retirement.
If you had received the right to an ex-spouses 401(k) then you may not be subject to the 10% penalty. However, since it is your 401(k), you are.
You would still have the penalty, as well as the tax. Sorry. However, if you still want to help your son with college, you could roll your 401(k) into a rollover IRA. Once there, the rules, if followed correctly, allow for you to distribute funds to pay for qualified college expenses (tuition, books, room and board, etc.).
There are only two places into which you can roll over a 401(k) balance that will allow you to avoid the tax and the penalty. You can roll over to a new employer 401(k) plan, provided the plan accepts rollovers, or to an IRA. Distributions are taxed, as you note but because you are under age 59 1/2, you would also be subject to the 10% penalty if you used a distribution to fund a 529 plan. Your marital circumstance does not create an exception.
What you should do is roll the 401(k) to an IRA, then take advantage of the distribution exception for direct payments for qualified higher education expenses for your son's college tuition when those expenses come due. You would still pay the income tax on the IRA distribution but the penalty would be waived if you pay for college with distributions from your IRA.
You don't say how old your son is but if he's is 11 or more years away from college, your IRA balance has more than a decade to grow, tax-deferred before you make distributions to pay for college. By that time, you'll be over 59/12 and exempt from the penalty.
First off, This would not be sensible and hopefully not advised by any financial advisor, unless that advisor makes their living off only selling 529's.
Unfortunately you have wrong info. The spouse receiving the the benefit/assets from a qualified plan (IRA, 401k, etc.) can then access those funds without paying the additional 10% early withdrawal penalty. The spouse who owned the IRA/401k and giving up the assets cannot avoid the extra 10% early withdrawal penalty.
Because it is a former employer, there are several other options. For example, Role it into a IRA. You can also convert it and role into Roth IRA (Yes you will pay the taxes on the coversion but no peanalty). Wait a minute, isn’t an IRA or Roth IRA still for retirement? Yes it is. But there are few reasons that allow for an early withdrawal without penalty. College expenses for the person’s spouse, children or self, currently qualifies as one of the reasons. So yes this would do the same thing that a 529 would do. Plus in an IRA or Roth you would have more options and flexability of how to invest the assets verses a 529. Not to mention if the child does not go to college, it remains your retirement account. another option, If you have new employer with 401k, you can roll it into that and look into taking loan from said 401k to pay for college.
Best of Luck
A divorce often allows your 401(k) to be transferred to your spouse's IRA without tax; I am guessing that is your initial comment. Unfortunately, you cannot roll over a 401(k) plan (pre-tax dollars in a retirement accounts) to a 529 plan (post-tax dollars into a qualified education account) under any circumstances; a divorce does not have any effect on this.
You can technically withdraw funds from the 401(k) and pay income taxes (and often a 10% penalty for early withdrawals prior to you turning 59 1/2), and then reinvest the funds in a 529 plan, but doing the former is usually a bad idea due to the tax and possible penalty, and the fact your son may not utilize the 529 funds, whose gains are then also taxed and penalized.
Keep the funds in your 401(k): Retirement plans can be withdrawn in the future to pay for a child's higher education expenses. Yes, they will be taxed, but the 10% penalty is waived.