How To Use Pensions and IRA's Without Penalty Before Age 59 1/2

Question: During the divorce process, I have seen the lawyers involved as "problem makers" rather than "problem solvers" -- at significant cost to me and my wife. Rather than being creative and helping us fashion viable remedies, they have chosen to ignore our problems and waste time. Our problem is cashflow: As a professional, I earn a good living, but the bucks simply are not there to support the lifestyle we once enjoyed as a family. Although our net worth has increased, the income from the stocks we have purchased over the years is minimal, and the capital gains taxes would kill us if we sold these assets. Although I have been able to put away nearly $300,000 in my pension plan, the lawyers say this can not be touched without taxes and penalties. My wife is 45 and unemployed outside the home. At 47, I still have a number of productive years ahead of me, so it seems that there should be ways in which to take advantage of what we have accumulated without getting pounded by the system and the government. Any "creative" ideas?

Answer: 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 creative production of cash flow is often essential. Contrary to what your lawyers have advised you, monies from your qualified retirement plan (Pension, Profit Sharing Plan, 401(k), IRA's, 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.

Although distributions from a qualified plan prior to age 59 and a half will normally trigger a 10% penalty in addition to income tax, you can transfer all or part of the funds in your plan to your wife's IRA without tax or penalty through a qualified domestic relations order (QDRO).

Once properly transferred from one qualified plan to another without tax or penalty, even though your wife has not yet reached 59 and one-half, she can withdraw an series substantially equal installments for five years or until she reaches age 59 and one-half, whichever is later, and not pay the 10% penalty. Once the amount is determined and payments begin, your wife will not be able to change the amount because, if modified, penalties will be retroactive to the first payment. Your wife will be required to pay income taxes on the amounts withdrawn.

Here's an example: If half of your pension ($150,000) was rolled over to your wife's IRA, she could withdraw more than $1,000 per month and still have more than $80,000 remaining at the end of 15 years. These distributions could be used to supplement other support payments you make to her. By contributing up to $30,000 annually into your pension, you should be able to replenish your pension rather quickly.

Bottom Line: Qualified money can play an important role in the settlement of domestic relations disputes by creating or supplementing an income stream. The substantial equal withdrawal option will work with any amount, but be sure to contact professionals who can help you fashion the rollover and structure the substantially equal payments. For more information, you can order an audiotape produced by The American Academy of Matrimonial Lawyers -- "Retirement Plans at Divorce" -- by looking in our Resource Library.

SoloFact: After divorce, spouses should make sure to change the beneficiary of their pensions to avoid unintended results. Some courts have ruled that even though a former spouse has signed a general waiver of rights to the pension, if the beneficiary not changed, the former spouse may still be entitled to the proceeds. Therefore, it is a good idea to 1) specifically identify the pension in the waiver and 2) make sure to change of beneficiary immediately after divorce so it will not be forgotten.