Divorce in Michigan – Avoiding a 10% early retirement penalty: In almost every divorce case, at least one party is a beneficiary of a retirement account and in many instances, a retirement account is a marital asset that can be divided without a 10% early withdrawal penalty.
In simple terms, if a portion of a retirement plan was contributed to during the course of the marriage it is a marital asset subject to division.
Retirement accounts come in many forms with unique titles. Some of the most common retirement plans include a Roth IRA, 401(K), 403(b), Keogh, Self Employment Plan, 457, profit sharing plan and defined benefit plans.
Some retirement plans, like a Roth IRA contain after tax dollars while others, like a 401(k) or 403(b) are tax deferred.
Most tax deferred plans, like a 401(k) or 403(b) are considered “qualified plans” because employers are allowed to take deductions for contributions under the Employee Retirment Income Security Act (ERISA). However, early withdrawals by employees are subject to a 10% early withdrawal penalty in addition to income tax.
When dividing retirement accounts in a divorce, there are circumstances where the 10% penalty can be avoided. One strategy is to roll over the retirement account, another strategy is to have the non-participant party withdraw cash from a qualified plan and avoid the 10% early withdrawal penalty. This is authorized under Internal Revenue Code section 72(t)(2)(D). After taxes, these funds can be used for a multiple of purposes including to satisfy a debt or saved as cash.
The 10% penalty must be paid by the participant of the plan if he/she makes an early withdraw. This penalty is not accessed to his/her spouse. A common strategy to avoid the 10% early withdraw penalty all together is for the participant to transfer his/her share of the retirement to his/her spouse in the divorce and offset the transfer with an award of another asset or to satisfy a joint debt. This brings more money to the table for the parties to work with. A win win.
If your attorney is not familiar with the retirement laws, this can lead to an unfair division of property because only one party (the participant) is typically subject to the 10% early withdraw penalty.
Not all retirement accounts are alike. Your divorce lawyer and accountant should understand the differences when negotiating your case.
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By: Daniel Findling
The Divorce Guy, Michigan Divorce Attorneys and Specialists