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Hi! I am a single woman recently divorced who is receiving

Customer Question
Hi! I am a...
Hi! I am a single woman recently divorced who is receiving 63,000 from a QDRO settlement. I was informed that if I choose to cash out my account that I would be subject to tax penalty of 20%....upfront. My question is that a friend of mine rolled her QDRO settlement over to an IRA and then took out money as she needed. I know this dictates a new penalty of 10% on top of the 20% in the form of taxes but this wouldnt be done upfront. The 30% would be taken out at tax time. Is this wise or should I just go the traditional route of having the 20% taken upfront. I recently lost my job and need this income to live so the less I have to give up ufront the better I would feel until I find a job.

Please advise.

Thanks,

AA
Submitted: 8 years ago.Category: Tax
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10/2/2009
Tax Professional: Bill, Enrolled Agent replied 8 years ago
Bill
Bill, Enrolled Agent
Category: Tax
Satisfied Customers: 3,153
Experience: EA, CEBS - 35 years experience providing financial advice
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The 10% penalty for distributions prior to age 59 1/2 does not apply to QDRO distributions from a qualified plan (such as a pension or 401(k)) but it does apply to IRA distributions unless another exception applies. So if you rollover the funds to an IRA and then take a distribution you will incur the 10% penalty.

 

The 20% penalty that you were informed about is not a penalty, it is tax withholding that is required for distributions from qualified plans regardless of a person's age or distribution reason. The taxes that are withheld will be entered as a credit against any taxes you owe when you file your tax return.

 

So depending on how much you will need to live on until you get another job, you could take a partial distribution for your estimated living expenses and roll the balance to an IRA. The partial distribution amount will avoid the 10% penalty tax.

 

Another consideration would be to project the amount of tax you will pay if you take the entire distribution this year (including your other income for the year) without the penalty and compare these taxes to how much you would pay in total taxes over 2 years if you take a partial distribution this year and IRA distributions next year for living expenses if you don't obtain another job but pay the penalty with lower overall income next year.

 

 

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Customer reply replied 8 years ago
Thanks for your help! How can I project the amount of tax if I take the entire distribution this year? Also, since the 20% is a credit against taxes owed....will there be a chance that I may get a refund of the amount paid? my friend was telling my her ex suggested the 30% 20 +10 penalty for her so that she may have more money upfront but this seems risky to me since she could be hit with unexpected taxes come tax time. also, do I have another option since I am unemployed as far as rollover I was told the only other place I could roll over to was an Ira. Please advice with any links necessary.

cheers!

AA
Tax Professional: Bill, Enrolled Agent replied 8 years ago

It's possible you could get a refund. It would depend on your other income for the year. If you provide me an estimate of your total income this year (wages, investment earnings, unemployment compensation, any other income) and your filing status then I can give an approximate amount of federal tax you will owe.

 

You can roll the funds over into another retirement plan such as a 401(k) or 403(b) with your former employer but the IRA provides the most flexibility.

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Customer reply replied 8 years ago
I have been unemployed since october 2008. I have not worked in 2009 am back in school. Student loan interest is approximately 340 per year for previous student loans. I did not collect unemployment and have been living on 4000 per month alimony until august of this year 2009. the settlement agreement presented in court stated my alimony was non taxable. I dont have any investment earnings except for the qdro. I used all my savings thus far and did not contribute to any 401k at my previous job since my ex controlled all financial matters in the household that is why he is an ex. I am starting to manage my own finances. I had to go back to live with my parents until I get on my feet again so until I get a job...my income for will be the amount of the qdro. the amount of the qdro is 63,941.50 full amount.

thank you,

AA
Tax Professional: Bill, Enrolled Agent replied 8 years ago

Generally, alimony payments are taxable. However. payments that are designated as "not alimony" are not taxable if there is a provision in your divorce document that states the payments are not deductible as alimony by your spouse and are excludable from your income. You spouse can exclude the payments from income only if you attach a copy of the instrument designating them as not alimony to your tax return.

 

Assuming the payments are not taxable, then if you withdraw the entire $63,941.50 and file single, then your federal income taxes would be approximately $9,835. So if you took a distribution of the entire amount and 20% was withheld ($12,788) then you would get a refund of almost $3,000.

 

Another option that might be available if you are going to be paying higher education expenses in 2010, would be to roll some of the funds to the IRA and take withdrawals in 2010 not in excess of those expenses as IRA withdrawals for higher education expenses are exempt from the 10% penalty.

 

See pages 54 - 55 - http://www.irs.gov/pub/irs-pdf/p590.pdf

 

http://www.irs.gov/publications/p504/ar02.html#en_US_publink100044197

 

Bill
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Customer reply replied 8 years ago
Bill,

Thank you for all your help! I value your expertise and thank you for your time.

Best Regards,
AA
Tax Professional: Bill, Enrolled Agent replied 8 years ago

Thank you for using Just Answer.

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