Couples facing high-asset divorces have many financial issues to address. In addition to identifying and valuing their resources, they often need to come up with creative solutions for dividing those assets.
Some marital property requires more careful consideration than other resources. For example, if either spouse has funded a 401(k) with marital income, dividing the account may be necessary to achieve a reasonable property division settlement. Any early withdrawals from an account could result in income tax consequences. The right documentation can prevent an increase in spouses’ income tax burdens.
401(k) withdrawals are income
Professionals make pre-tax deposits into their 401(k) accounts. This process helps reduce their taxable income for the year, potentially helping to minimize their income tax obligations now. They then pay taxes on the amounts they withdraw after retirement, when their income and therefore the applicable tax rate may be significantly lower.
If spouses must divide a 401(k) to reach a fair settlement, they may need to have an attorney draft a qualified domestic relations order (QDRO) after the courts approve their final property division decree. The appropriate execution of a QDRO can eliminate immediate income tax obligations and also the 10% penalty imposed on early withdrawals from tax-deferred retirement accounts.
While executing the QDRO, a financial professional moves a specific percentage of the account’s balance into a new account in the name of the other spouse. So long as the funds remain in the account, neither spouse has to declare the portion of the account moved to a new account as income.
Working with an attorney to address complex property division matters can help people limit the tax implications of a high-asset divorce. Retirement accounts and other valuable resources require special consideration, as they could trigger income tax obligations.