Hardship distribution due to divorce

[JPIngold]

A participant says he needs $30,000 in order to "settle" his divorce. If he doesn't come up with the $30,000, he will lose his house. Could this be considered an eligible hardship to "purchase" a home --- in essence, he is purchasing his wife's interest in the home for $30,000.

[chc93]

A participant says he needs $30,000 in order to "settle" his divorce. If he doesn't come up with the $30,000, he will lose his house. Could this be considered an eligible hardship to "purchase" a home --- in essence, he is purchasing his wife's interest in the home for $30,000.

Would you consider that this is to "prevent eviction" from a principal residence?

[JPIngold]

I was somewhat linking it to that argument as well. The bottom line is that if the guy doesn't come up with $30,000 somewhere (and the bank isn't willing to loan it to him), he's going to lose his house.

[hr for me]

Has the plan sponsor been given notice of a possible QDRO that involves 401(k) assets? One concern would be that he is using community property funds that his almost-ex-spouse might have some rights to (depending on the state marital property laws and on what the divorce agreement is)...

If he takes $30k and the QDRO requires him to split his 401k balance with the almost-ex-spouse will there be enough to do so? Or is he doing an end run around a possible QDRO?

I don't disagree with your argument of preventing eviction, but would be concerned about processing any distribution in the midst of the divorce/QDRO situation.

[rcline46]

What do you have as physical proof - papers, something that he needs the $30,000 to keep the house?

[JPIngold]

To hr for me --- No QDRO has been discussed.

To rcline46 ---- there is a letter from the attorney that describes the situation and states that the $30,000 is necessary or they will have to sell the house and split the proceeds. The bank has refused to loan him the money.

Pretty sad deal for the guy.

[Mike Preston]

Sad or not, I don't think it satisfies the safe-harbor definition. If things are as they say, it should be a simple matter to have a QDRO prepared that accomplishes what they want.

[GMK]

I agree with you, Mike, except for the part where you put a QDRO and "a simple matter" in the same sentence.

[jpod]

Does he need $30,000 before tax and 10% penalty or $30,000 after tax and penalty? Regardless, and admittedly not responsive to the question, but if there is sufficient equity in the house which can be pulled out tax-free maybe he's better off financially selling the house.

[My 2 cents]

Does he need $30,000 before tax and 10% penalty or $30,000 after tax and penalty? Regardless, and admittedly not responsive to the question, but if there is sufficient equity in the house which can be pulled out tax-free maybe he's better off financially selling the house.

1. Good point - unlike a split of the account with no distributions (which is what would happen under a QDRO), the withdrawal would be a fully taxable event (possibly also subject to the 10% excise tax, depending on the participant's age).

2. If I did not misunderstand the earlier posts, the mortgage holder refused to allow an equity loan on the house (or the equity was already loaned out so that an equity loan was not available). Either way, it was stated that the bank was not willing to loan him that money.

[jpod]

I am not following your point 2. The facts stated are that he CAN satisfy the $30K obligation by selling the house, or at least that's my interpretation of what is stated. Maybe there isn't enough equity for a second mortgage or home equity loan, but there must be enough equity after commission and other closing costs to cover the $30k or why would it even be a "sad" alternative?

[ESOP Guy]

To some degree you have to be careful on what you recommend but I don't see why the two people don't get a QDRO.

I remember when my parents were getting a divorce decades ago my father who had a high income was more interested in preserving retirement plans (he figured he could get a mortgage on a new home if he had to) and my mom having kids in the house and lower income valued the home that was mostly paid for. So when splitting the assets dad got 100% of the retirement funds and mom got 100% of the house.

Nothing in the rules require a QDRO to split things 50/50. If he wants the house and she wants cash a divorce decree and QDRO could be written to do that. I suppose the ex-spouse doesn't want to be the one to pay taxes if they got the QDRO proceeds. Then again the QDRO amount can be grossed up for taxes.

Like so much in life it is all negotiable.

[My 2 cents]

To some degree you have to be careful on what you recommend but I don't see why the two people don't get a QDRO.

I remember when my parents were getting a divorce decades ago my father who had a high income was more interested in preserving retirement plans (he figured he could get a mortgage on a new home if he had to) and my mom having kids in the house and lower income valued the home that was mostly paid for. So when splitting the assets dad got 100% of the retirement funds and mom got 100% of the house.

Nothing in the rules require a QDRO to split things 50/50. If he wants the house and she wants cash a divorce decree and QDRO could be written to do that. I suppose the ex-spouse doesn't want to be the one to pay taxes if they got the QDRO proceeds. Then again the QDRO amount can be grossed up for taxes.

Like so much in life it is all negotiable.

The QDRO amount would not be subject to immediate taxation, but the amount allocated to the alternate payee might be something that the alternate payee could take an immediate distribution of. I don't work on defined contribution plans - would it be proper for a QDRO under a defined contribution plan to specify that the amount allocated to the alternate payee is to be paid out at once in cash (with or without grossing up for the potential taxes)?

As for the second point I made in my earlier post - I have no idea what the status is of the property/mortgage and why the bank is unwilling to loan $30,000 to a participant whose house could be sold for a net profit of at least that amount. I was just noting that it had been stated that the bank would not do so. I have no way of knowing whether that makes any real sense. Actually, post #6 does not actually say that the proceeds of the sale would be as much as $30,000, just that if the participant does not come up with $30,000, the house will have to be sold and the proceeds (whatever they may be) would then be split. Can't get blood from a stone - if the house must be sold, maybe they would each net $5,000 after the mortgage is paid off and the commission is paid. Or maybe it would be $60,000 each. Not made clear, just that the participant, other than through a hardship distribution, has not other way of satisfying the soon-to-be ex-spouse's demand.

If the funds have to come from the retirement plan, maybe obtaining a QDRO would be the most appropriate thing to do.

[MoJo]

Does the plan offer loans? If it does, would be an easier way to get the money (provided all the "conditions" are satisfied...).

[Mike Preston]

Wouldn't the participant have had to exhaust all loan possibilities from the plan (or any other plan of the employer) before even considering a hardship distribution?

[Belgarath]

It depends. If the loan repayment would increase the "hardship" then the loan doesn't have to be taken first. See, for example, 1.401((k)-1(d)(3)(iv)(D).

[chc93]

So... is a loan an option in this particular case?

[JPIngold]

Sorry I was at a tax client's office all day yesterday and this morning and couldn't chime back in. Here are some factors (which makes reality always more difficult than theory):

• Plan does not allow loans;
• The participant has been told without hesitation that he would not qualify for a home equity loan because he is actually not working right now as he is on workman's comp leave;
• The workman's compensation leave is not sufficient enough to qualify for social security disability, which would allow him to take a distribution;
• The attorneys have already settled the divorce without even talking to the employer about the possibility of a QDRO;
• Suddenly, the guy needs $30,000 to even up the property settlement (which is tax-free to her), which means her attorney was smarter than his attorney since he knew that would be tax-free versus the ultimate taxation of the money received via the QDRO;
• This guy really wants to keep this house, partially because he may not be able to clear the $30,000 on a sale.

Lawyers sometimes create little choice for the parties involved.

[GMK]

The attorneys have already settled the divorce without even talking to the employer about the possibility of a QDRO.

Isn't this still negotiable?

Unless the judge has already ruled, couldn't they tear up the current papers and as ESOP Guy says, rewrite the terms to include a QDRO that covers the $30k plus the taxes. Doesn't have to be a 50/50 split of the plan assets.

[BG5150]

So he's not really "forced" to sell his home. It's just that circumstances are such that it's the best way to accomplish his goal.

He is not being "evicted."

He has a "bill" from his ex-wife for $30,000, and selling the house is an unfortunate way to satisfy that debt. It is not a letter from the bank that says "pay up or get out."

he already "owns" the house, so he would not be purchasing a principal residence.

This is all assuming the plan uses merely the safe harbor conditions for issuing hardship distributions.

[jpod]

I am reading the additional facts to mean that he needs $30,000 after tax, so he really needs maybe $50,000 pre-tax, assuming there is a 10% additional 72(t) tax.

Hard to believe it makes sense to use $50,000 of tax deferred retirement money just for the sake of keeping a house, but I guess there could be other, non-financial factors in play for keeping the house at all costs.