In most retirement plans, such as a 401(k) or traditional IRA, taxes are paid when funds are distributed, i.e. “cashed out” of the plan. Taxes would be paid at a rate according to the income level of the person cashing out at the time of the distribution. Presumably, if an account is distributed during retirement, the person cashing out the retirement plan is earning minimal income and would be taxed at a lower tax bracket, thus minimizing his/her tax payment to the IRS.
In divorce cases, retirement plans are often divided between the spouses shortly after the divorce. The division of a retirement plan is a transfer of retirement funds, not a distribution, or “cash out,” and, therefore, does not result in tax liabilities.
The process of dividing a retirement plan, and ensuring that there is no tax liability, varies depending on the type of plan. For a 401(k), a Qualified Domestic Relations Order (QDRO) is needed to divide the funds. This court order assigns the rights of an employee’s retirement plan to his/her ex-spouse, also known as an “Alternate Payee.” This allows the ex-spouse to receive benefits, i.e., money, under the plan without tax consequences. Later, when the money is distributed, taxes would have to be paid. IRA accounts usually do not require a QDRO and can be divided without tax consequences by rolling funds from one spouse’s IRA plan to the other spouse’s IRA plan. Again, taxes would be owed when the funds are distributed, not divided.
The Botti Law Firm has been serving DuPage and Cook County residents for nearly 50 years. If you would like to speak to one of our experienced attorneys, please email us or call (630) 573-8585 to schedule a free consultation.
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The Botti Law Firm, P.C., conveniently located in Oak Brook and Wheaton, is a full service law firm that offers comprehensive legal representation to individuals, families, businesses and professionals from the Chicago area, including Cook, Kane, DuPage, Lake, Will and Kendall Counties, to the rest of the United States. Our experienced trial attorneys are dedicated to obtaining successful results for our clients, in both state and federal courts.
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