Penalty-Free Distributions from Retirement Plans Before Age 59 1/2: A Window of Opportunity

This is the first in a multi-part series by Christopher M. Moore

It’s an all-too familiar scene. The parties are nearing the end of their dissolution proceeding. The case is settled and the assets are ready to be divided, but there is little cash. The cost of setting up two households in place of one and the payment of spousal support have created a chronic cash shortage. Unpaid bills have accumulated. One spouse needs a new home, another must buy a new car to replace the 1970 gas-guzzler that finally gave up the ghost. Attorneys’ fees and costs must be paid. The sale of the family residence produces some cash, but not enough. There are retirement plan accounts, but the parties are under 59½ and the tax cost of withdrawing the money, particularly after the 10 percent penalty tax is added, are prohibitive.

Is there a way a spouse can tap these retirement plan assets without penalty before age 59½? It appears there may be.

Family law practitioners are familiar with the Retirement Equity Act of 1984 (“REA”), which allows the non-employee spouse to receive part of the employee spouse’s retirement plan interest pursuant to a Qualified Domestic Relations Order (“QDRO”). These benefits can be paid directly to the non-employee spouse or rolled over into an individual retirement account (“IRA”) in the spouse’s name. Benefits received directly by the spouse are taxable as ordinary income. Benefits rolled over into an IRA by the spouse maintain their tax-deferred status until withdrawn.

It is also well known that withdrawals from a qualified retirement plan prior to age 59½ are subject to a 10 percent penalty tax. Internal Revenue Code §72(t). There are two exceptions, however, to the general rule imposing the penalty tax on pre-age 59½ distributions. These exceptions can provide valuable planning opportunities in situations where there are significant retirement plan benefits and the non-employee spouse is under age 59½.

Retirement Plan Interests as Community Property

Retirement plan interests are community property to the extent that the benefits are earned or accrued during the marriage. There are two judicially-approved ways to divide the community interest in a retirement plan. The first method is to reserve jurisdiction over the plan interest and divide each payment between the spouses based on the respective community and separate interests, as and when each payment is received. The second is to value the plan interest actuarially, award assets of equivalent value to the non-employee spouse, and award the entire plan interest to the employee spouse. In re Marriage of Brown, 15 Cal.3d 838 (1976).

As noted above, REA allows the non-employee spouse to withdraw a portion of the employee spouse’s retirement plan account pursuant to a QDRO.

Chris-Moore2Christopher 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.

the phantom returns

What is Forensic Accounting?

Forensic, according to the Webster’s Dictionary, means

  • “belonging to, used in or suitable to courts of judicature or to public discussion and debate”
  • “pertaining to or employed in legal proceedings or argumentation.”

Accounting, as defined by The Random House Dictionary, is “the system of organizing, maintaining … the financial records of a company or an individual.”

Forensic Accounting, then, is the practice of accounting in support of litigation. A Forensic Accountant provides an accounting analysis suitable to the court that will form the basis for discussion, debate and ultimately judicial decision. A Forensic Accountant utilizes specialized accounting skills to conduct an investigation into the actual earnings and income stream of individuals and businesses. A benefit of employing a Forensic Accountant is for his or her ability to communicate financial information clearly and concisely in a courtroom setting.

After a Forensic Accountant is retained for a marital dissolution case, he or she typically would:

  • Assist the attorney in defining the accounting matters
  • Assist the attorney with discovery requests
  • Summarize and analyze financial data and transactions
  • Prepare reports and declarations
  • Perform complex business valuations under family law rules
  • Attend depositions to support opposing witness examination
  • Assist in settlement negotiations
  • Assess tax aspects of proposed settlements
  • Assess issues for trial
  • Prepare court exhibits for trial
  • Testify as an expert witness in trial, if necessary
  • Support attorney in witness cross examination at trial
  • Review judgment for accuracy of findings

Ron-Anfuso2Ron J. Anfuso, CPA, ABV, CFF, CDFA, FABFA is a Forensic Accountant and expert witness in the Los Angeles area. He has over 19 years experience in the valuation, financial, accounting and tax aspects of marital dissolution matters, which includes conducting business valuations, gross cash flow analyses, and tracings, as well as performing Moore/Marsden and other dissolution-related accounting calculations. He is also a founding member of A Better Divorce, and has prepared over 40 collaborative law cases.