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How To Use Qualifed Money to Create More Cashflow At Divorce Before Age 59 Ĺ -- Without Penalty




At divorce, the income that supported one family under one roof must provide for two separate households. For husband, wife, and children to enjoy even a semblance of their former standards of living, the production of cash flow is essential.


Money from a qualified retirement plan (Pension, Profit Sharing Plan, 401(k), IRA, etc.) can be used at the time of a divorce to increase cash flow. Depending on amounts and needs, this cash flow can enhance, reduce, or, in some instances, replace spousal support.


The ages of the parties determine the tax treatment of the money coming from these retirement plans. There is one set of rules for those who have not yet reached 59½; another for those between 59½ and 70½, and still another for those who are 70½ and older. Today, we deal only with those rules applicable to people who have not reached age 59½.


Normally, distributions from a qualified plan prior to age 59½ will trigger a 10% penalty in addition to the usual and expected income tax ((See §72(t)); however, §72(t)(2)(C) exempts this 10% penalty from distributions made to alternate payees pursuant to a qualified domestic relations order (QDRO). This means, of course, that by complying with a QDRO or by making a trustee-to-trustee transfer, one spouse can transfer part or all of his or her qualified plan to the other spouse. No tax or penalty will be imposed if the transfer is made from one qualified plan to another.


Under the old rules, money from the plan could be rolled directly to the transferee spouse who then had 60 days within which to roll this money into his or her own qualified account (usually an IRA). If this was done within 60 days, there was no tax or penalty imposed.


Now, however, if the qualified money is first rolled to an individual and then to a qualified account, the trustee of the plan must withhold and pay to the IRS an amount equal to 20% of the gross rollover as taxes. The transferee spouse receives the remaining 80% and can, within 60 days, roll this 80% into his or her own qualified IRA with no tax or penalty on this amount. There remains a problem, however: Since the 20% which was withheld was not placed into the IRA, the transferee spouse must pay income tax and the 10% penalty on the 20%.


This situation can be remedied if the receiving spouse takes an amount equal to the 20% from other assets and places this amount into the qualified account so that an amount equal to 100% of the gross rollover is deposited into the IRA. In this way, the 20% paid to the IRS can be recovered when the next income tax return is filed. But this means waiting until next April to recover the money -- and not getting any investment return on that portion of the money until then.


What is the answer? The entire amount to be transferred from the original plan should be transferred directly to the new plan so that the money never passes through the hands of the receiving spouse. By the transferee spouse not receiving the money, there is no tax and no penalty. Since the rollover need not be aggregated in one qualified account, several IRAís can be established to receive various parts of the rollover.


Let's assume that funds have been properly transferred from one qualified plan to another without tax or penalty. Let's also assume that the recipient spouse has not yet reached age 59½. The next problem we face is how to create spendable income from this qualified asset without paying the 10% penalty.



Section 72(t)(2)(A)(iv) provides a solution to our problem by creating an exception so long as the withdrawals are "... part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or life expectancies) of such employee and his designated beneficiary." Therefore, by using a reasonable interest rate assumption amortized over the recipientís life expectancy, we can in this fashion provide income without the 10% penalty.


But there are certain restrictions: Once the amount is determined and payments begin, the amount of the payments cannot be changed without penalty for five years or until the recipient reaches age 59½, whichever is later. For example, if the recipient spouse is age 45 and elects a withdrawal amount, the amount of the withdrawal cannot be changed until the recipient reaches age of 59½. If the recipientís age is 57, the amount can not be changed until the recipient reaches age 62. You can split it into as many IRA's as you need. This gives your clients a lot of flexibility.


And since "reasonable" interest assumption is not defined by IRS, the calculation leaves the door open, maybe ever-so-slightly, for problems should Uncle Sam not agree with the chosen rate. For this reason you should seek written indemnification for your clients so that, should there be a penalty assessed, your clients should not have to pay it. This written indemnification is essential.


Here are some examples....


Letís assume that the husband is 50 and the wife is 45, and that he has $500,000 in his qualified retirement plan. If, by QDRO or other suitable vehicle, he transfers qualified money of $150,000, $250,000, and $500,000 into her IRA annuity, the following income options are available to her:


$150,000 Qualified Money


Current Assumed Monthly Account Balance

Interest Rate For Income After 15 Years

Factor Calculation Desired

7.02% 6.5% $1,053.00 $76,997

6.34% 6.5% $ 951.00 $107,959

5.82% 6.5% $ 873.00 $131,636

5.16% 6.5% $ 774.00 $161,686


$250,000 Qualified Money


Current Assumed Monthly Account Balance

Interest Rate For Income After 15 Years

Factor Calculation Desired

7.02% 6.5% $1,755.00 $128,329

6.34% 6.5% $1,585.00 $179,932

5.82% 6.5% $1,455.00 $219,393

5.16% 6.5% $1,290.00 $269,477


$500,000 Qualified Money


Current Assumed Monthly Account Balance

Interest Rate For Income After 15 Years

Factor Calculation Desired

7.02% 6.5% $3,510.00 $256,658

6.34% 6.5% $3,170.00 $359,863

5.82% 6.5% $2,910.00 $438,785

5.16% 6.5% $2,580.00 $538,955



If the same 45 year old wife receives $500,000, chooses the income she needed, and then splits the amount into two IRA's, hereís what can happen:


$394,321 Qualified Money Goes Into IRA #1


Current Assumed Monthly Account Balance

Interest Rate For Income After 15 Years

Factor Calculation Desired

7.02% 6.5% $2,768.13 $202,413

6.34% 6.5% $2,500.00 $283,802

5.82% 6.5% $2,294.95 $346,044

5.16% 6.5% $2,034.70 $425,041


The Remaining $105,679 Qualified Money Goes Into IRA #2


Then, 15 Years Later, Assuming $2,500 Per Month Is Chosen....


Balance in IRA #1 = $283,802


Balance in IRA #2 = $255,201

(Assuming $105,679 compounding at 6.5% for 15 years)










After the chosen plan has been implemented, the receiving spouse will not have to worry about receiving alimony payments for this amount which are being paid from the recipient's IRA, not by the adverse party. This stream of income is, therefore, sheltered from DEFAULT, DISABILITY, and DEATH of the former spouse.


From the paying spouse's point of view, there is no monthly reminder of the divorce as a result of an obligation to pay alimony--or at least payment of a reduced sum. And the monied spouse has 15 - 20 years to rebuild a retirement plan with as much as $30,000 deductible dollars per year.


Remember: The monies received will be subject to income taxes as received, but there will be no penalty. And if the recipient spouse in our example has the penalty imposed 10 years into the program, the penalty will be retroactive to day one. Thatís why it is important to get written indemnification that the amount of distribution is correct. Remember too that if the estate is large enough, the value of the unwithdrawn monies will be subject to estate taxes Ė meaning that consideration should be given to having enough life insurance in order to furnish liquidity. This life insurance should be owned in such a way that it will not be part of the taxable estate. If necessary, part of the income flow before death can be used to buy wealth replacement life insurance.


Bottom Line: Qualified money can play an important role in the settlement of domestic relations disputes. By creating or supplementing an income stream that can be received each month without the uncertainty of personal obligations and personal checks, the use of substantially equal installments should become an important part of your negotiations. The substantial equal withdrawal option will work with any amount. But be sure you deal only with experienced professionals.


Substantial Equal Withdrawal Option Information


Please fax or email to me substantial equal withdrawal option information concerning the following factual situation with no obligation:


Name (optional):________________________________________


City and State of Residence______________________________


Amount of Qualified Money Involved______________________________


Birth Date of Person Seeking Withdrawals _____________________


Person Requesting Information




Fax # (_____)_____________Phone # (_____)______________ E-mail _________


Complete and Fax Toll-Free To 1-800-257-4343

or email information to




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