When people divorce in Minnesota, they need to be careful with how they divide their retirement accounts. People who take early withdrawals from their retirement accounts may face substantial penalties. Withdrawals that are made from a retirement account to pay the other spouse must be done correctly to avoid tax penalties.
The Internal Revenue Service assesses a 10% early withdrawal penalty on amounts that are withdrawn from 401(k)s and IRAs before the account holder is 59 1/2. The penalty is not assessed when withdrawals are made under a qualified domestic relations order and paid to the other spouse. The other spouse can open his or her own IRA and have the funds transferred into it.
In one case that illustrates the dangers of handling IRAs incorrectly in divorces, a woman transferred funds from her IRA to an IRA that her husband had opened. The man subsequently withdrew the money that she had transferred to the IRA account and closed it. However, he was not 59 1/2 yet. He was assessed a 10% penalty on the $10,000 he had withdrawn and also had to include the money as income on his tax return. Withdrawals from an IRA in a divorce must be made under a QDRO. If they fall outside of the order, penalties can be assessed.
People who have IRAs or employer-sponsored retirement plans might want to talk to experienced divorce attorneys before they take withdrawals from their accounts during divorces. The attorneys might help their clients to avoid tax consequences by preparing QDROs that reflect how the funds should be transferred. The attorneys might also negotiate with the other spouse to try to secure a property settlement agreement that protects their clients’ current financial interests and their ability to retire on time in the future.