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Do penalties apply when dividing retirement savings in a divorce?

On Behalf of | Feb 6, 2024 | Property Division

Retirement savings are often among the personal resources that people prioritize in a divorce. No one wants to delay or substantially alter their retirement plans because their marriage ends. Therefore, people are often very protective of retirement resources during a divorce.

Some people learn with disappointment that a large portion of their retirement account could be subject to division. Contributions made during the marriage are often part of the marital estate during a divorce. Does someone also have to worry about taxes and penalties when dividing retirement savings during divorce proceedings?

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One of the benefits of saving money for retirement is that people can reduce their taxable income. The funds that they set aside are not accessible until they reach retirement age. They pay taxes on those funds when they eventually withdraw them.

They pay the taxes at a time when their household income is lower. They may ultimately pay far fewer taxes on those funds using this method. However, if someone makes an early withdrawal from a retirement savings account, they may have to worry about both taxes and penalties. In addition to paying income tax on the funds withdrawn, people typically need to pay a 10% penalty. The goal of such penalties is to prevent people from diminishing their retirement savings.

The good news for those preparing for divorce is that divorce proceedings are among the rare scenarios in which people can divide retirement accounts without penalties or taxes. If the spouses successfully draft and record a qualified domestic relations order (QDRO), they can split the funds in the retirement account into two separate accounts without either spouse paying income taxes or penalties on that distribution.

Seeking legal guidance concerning major property division matters can help people use systems that may preserve more of their resources during a divorce.