By Elizabeth J. Billies | Esquire
Yes! A withdrawal from a 401(k) creates income for which the recipient of the withdrawn funds will be taxed. For example, if the parties are contemplating transferring retirement assets from one spouse to the other, and do not want the funds to be taxed, they should transfer the monies from one party’s retirement account to the other. Under this procedure, the money is not actually withdrawn from the original account. Rather, it is merely moved from one retirement vehicle to another following a procedure outlined by the retirement plans. Thus, as no cash has actually been received by either party, there is nothing to tax. However, don’t forget that when the receiving party withdraws those funds at retirement, those monies are taxed at that person’s income tax rate.
In many cases, there is little cash available for division in a divorce settlement. However, there are many instances when a party needs to withdraw monies from a retirement plan in order to satisfy debts, pay bills, etc. prior to retirement. In that case, the transferring party should still transfer the monies to the other’s retirement account to avoid paying taxes. After the transfer, the receiving party may withdraw part or all the funds subject to income taxes and early withdrawal penalties. Unfortunately, divorce is not a life event that makes these withdrawals exempt from IRS penalties. It is best to consult your attorney and/or accountant before make such financial moves to best avoid any unnecessary payments to Uncle Sam.