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Dr. Fiona Chen
Dr. Fiona Chen, Certified Public Accountant (CPA)
Category: Finance
Satisfied Customers: 473
Experience:  Former IRS Revenue Agent
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I am recently divorced. How do I use my IRAs that i will be

Customer Question

I am recently divorced. How do I use my IRAs that i will be getting in the settlement to put money down on a townhouse without being penalized. Have you heard of self directed IRA? or rollover into annuities or QUdro? unsure of what any of this mean. Dont have alot of liquid assets and i am three years shy of the 591/2 age to take money out without penalty
JA: The accountant will know how to help. Is there anything else the accountant should be aware of?
Customer: There are two IRAs and one that is his 401K...I get half of each
Submitted: 5 months ago.
Category: Finance
Expert:  Dr. Fiona Chen replied 5 months ago.

Dear Customer,

Part I.

If you get IRA and/or 401(k) as part of a divorce settlement, early withdrawal exemption should apply to only to your ex-spouse if s/he withdrew the money and gave it to you, and the exemption should not apply to your distribution done by your. But nowadays, many spouse who obtained the retirement account applies the exemption, and even their accountants will prepare returns this way. According to tax law, it should not happen this way.

"The only divorce-related exception for IRAs is if you transfer your interest in the IRA to a spouse or former spouse, and the transfer is under a divorce or separation instrument (see IRC section 408(d)(6)). However, the transfer must be done by:

  • changing the name on the IRA from your name to that of your former spouse (if transferring your entire interest in that IRA), or
  • a trustee-to-trustee transfer from your IRA to one established by your former spouse. Note: an indirect rollover doesn't qualify as a transfer to your former spouse even if the distributed amount is deposited into your former spouse’s IRA within 60-days."
  • https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-distributions-withdrawals
  • https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-divorce

The distribution also will have regular income tax effect. If you are thinking to have down payment on a townhouse, the down payment must be a sort of sizeable. In a way, you will loose a lot of the money you got. If you go up to like 25%, even if you get 100,000, you will loose 25,000. The amount lost to taxes can be even higher if your other items on the tax return are high, or if your state taxes retirement income. You want to consult with your tax return preparer to see what the regular tax effect will be.

Part II.

The reason why in divorce people will get retirement for settlement is to keep the money and use it for retirement income in the future. It is advised that you try to keep the money as long as possible until after age 70 and half for required minimum withdrawal. As in the profession, we have see people fighting to avoid going on medicaid and into long term care facility and run out of money in their 70s, 80s, 90s, and even in age over 100. Please do long term planning and be patient with this money.

Even if you rent a townhouse to live in for now, say monthly rent is 1,200 and one year is 14,000. That is still just half of the tax amount you will loose over to pay tax to the government. Please do long term planning. If you can use your cash and/or increase current income, the money is current earned and used for current living expenses. Retirement savings need to be kept for retirement age use.

Part III.

All IRA accounts and most and if not all IRAs are self directed to a certain degree if you carefully select the investment items you see fit. Self directed IRA and/or Roth IRA is not what we usually think about. Many people transfer business activities or non-traditional investment items under them. In the short run, there is no known regulation on them. In the long-term, the IRS will one day catch up in manage and regulate these investment vehicles. My advice for you at this point is not to try to self-directed IRA for yourself at this point.

Part III.

It is similar to loosing a spouse. In general, after a major life event, do not do anything significantly financial wise within one year. There are people also advising not to get remarried within one year. Our system is grieving. Any spending decision or activity cannot be easily reversed.

Part IV.

Annuity IRA is fine to a certain degree. If that is what you are considering, research more and read on more. The person who sells us annuities, 30 days after they sell us, they obtain 6% to 10% commission. That is how much we loose out on the money. If we have to take the money out prior to the waiting period, there is potential penalties not only to the interest but also to the principal. There are also administrative cost we can be charged on. Usually, if someone has a lot of money, the person can afford to put "some" and a small portion of their assets aside to annuity. This is not something for the light-heart or uninformed person. The person has to know what what s/he is doing. Annuity is not FDIC insured. It is insured only by the earnings of an insurance company. Some states require insurance companies to take on each others annuities if one of them is bankrupt. But that amount is limited to a upper level, e.g., 100,000.

Part V.

The assets you got, half of the retirement account, I think, is the result of Qudro.

In sum, please consider to make a long-term plan. Increase and use your current earning power to live on earnings you can get for your current living expenses. Try not to touch the retirement accounts and leave them for the life time retirement age use. You are too young to use up or any part of the money for anything.

The website link below above are for your further reference on the exemption of additional income tax penalty for withdraw before 59.5.

Please feel free to follow up.

Regards,

Fiona

Fiona Chen, MPA, Ph.D., CPA, ABV, CFF, CITP

Expert:  Dr. Fiona Chen replied 5 months ago.

p.s. On the down payment, even the amount is 50,000, the tax effect can be high. Please have your tax return preparer simulate the the effect for your comprehensive planning.