This is the forth in a multi-part series by Christopher M. Moore. Read Part 1 (PENALTY-FREE DISTRIBUTIONS FROM RETIREMENT PLANS BEFORE AGE 59½ : A WINDOW OF OPPORTUNITY), Part 2 (Retirement Plan Interests as Community Property) and Part 3 (Taxation of Retirement Plan Withdrawals)
The two common opportunities for planning afforded by Code §72(t) are those relating to distribution pursuant to a QDRO and periodic distributions from an IRA. Any amount may be distributed in a lump sum directly from a qualified retirement plan (other than an IRA) to the non-employee spouse before age 59½, without imposition of the penalty tax. Where an IRA is involved, the benefits may still be withdrawn as periodic payments under Code 872(t,)(2)(A)(iv).
Where the retirement plan in question is something other than an IRA, therefore, the non-employee spouse may receive part or all of his or her share in a lump sum. if that option is available under the plan, at ordinary Income tax rates, without the imposition of the 10 percent penalty tax. even if the recipient spouse is under age 59½, This can be a source of cash for the purchase of a residence or other assets.
Where the retirement plan in question is an IRA or the plan proceeds have already been rolled into an IRA, the spouse still has the opportunity to receive periodic payments free of the additional tax. These payments will vary depending on the age of the spouse and may require an actuary to calculate them, but there is some flexibility in setting periodic distributions so that greater or lesser amounts may be taken if desired. Once periodic payments are begun, they may apparently be later changed or stopped. Because only periodic payments may be made from IRA’s and lump-sum withdrawals may be made from other retirement plans, any decision as to a lump-sum distribution should be made before rolling the non-participant spouse’s interest into an IRA.
The opportunity to withdraw retirement plan benefits without penalty appears particularly attractive with today’s relatively flat tax rates, which may make it possible to withdraw large amounts from a plan during a particular year at ordinary income tax rates without increasing the tax rates.
The availability of retirement plan funds without penalty increases the options available to the parties and also, of course, creates new arguments for the parties. The spouse who is still working and not receiving benefits from the plan, for example, may argue that the ability to reach retirement plan benefits without penalty should be considered as a basis for reduced support to the non-participant spouse.
The exceptions discussed above will not apply to every case, and in many cases where they do apply, the parties may decide not to take early distributions. Distributions, once taken, are still taxable, and there is a strong inducement to allow assets, whenever possible, to remain in the plan to grow and compound at tax-deferred rates.
Whatever the facts of a particular case, however, if there are retirement plan interests and either spouse is under age 59½ counsel may wish to consider taking advantage of the window of opportunity afforded by the exceptions to the penalty tax on premature distributions found in Code §72(t).
Christopher M. Moore is a certified family law specialist, a fellow of the American Academy of Matrimonial Lawyers and a member of A Better Divorce, having specialized in family law for many years. Those years as a litigator have taught him that Collaborative Practice is the best way to resolve a divorce. A collaborative case is always faster, costs less and is less stressful than a conventional case where the parties face court congestion, delays and an adversarial, often hostile, relationship. Click here for more information about Chris and his firm.