401K Liquidation Tax Nightmare (Divorce)

[Guest Fplanner2014]

John & Mary Smith are getting divorced. John has 600k old 401k and 175k in new 401k and he earns approximately 115k a year while Mary will earn 25k in 2014. Their attorneys mutually agreed along with the Smith's that John should cash out his 600k 401k to pay off the house for Mrs Smith (370K). I came onto the seen after John removed 600k from his retirement without a QDRO (Qualified Domestic Relations Order). I have put the breaks on this Ill-advised scheme. However, the custodian withheld 120k for taxes and penalties. Is there any way to get this withholding returned quickly? They now have 45 days to correct this IRS disaster. Mind you that the effective tax rate on 740k is 53% fed, State, and penalty. Apparently neither attorney considered the sheer tax onslaught this would lead to (400/hr doesn't by much these days). Nor did they consider the alternatives (72T to pay the mortgage over time). However, this 120k withholding will still kick their combined effective tax rate up considerably if it cannot be put into an IRA within 60 days!!! The Smiths are still legally married so this occurred before divorce was finalized (dumb). Any advice, direction would be great. I'm at a loss...

[Jim Chad]

Can he borrow $50,000 from his other 401(k) and roll that to an IRA?

[ESOP Guy]

Most likely the answer is "no" there isn't a good way to get the withholdings back. You might try and saber rattle at the custodian as this doesn't appear to be a valid distribution as there was no distributable event. But my guess is they are going to say they were just following the Plan Administrator's direction. But if they are willing to just cancel the checks and put the whole amount back into the plan and get the taxes back from the IRS seems like the best way. I just don't think the custodian is going to play along.

Next best advice would be to find the cash some place else and get an equal amount back into the plan. It isn't clear to me you could roll it to an IRA as this wasn't a valid distributions. They would get the money back in 2015 via a huge refund.

Sorry, you have a mess.