QDRO for transfer of Roth defined contribution plan

[fmsinc]

The court awarded my client a percentage share of her ex-husband's 401(k) account.  It turns out that abut 90% of his 401(k) are in a Roth funds.  I am working on the QDRO.  

She plans to take a taxable distribution since she needs the money now.  If the distribution was coming from a traditional pre-tax 401(k) it would be income taxable to her and the Plan would withhold 20% for Federal taxes, and there would be no 10% premature withdrawal penalty under IRC 72(t)(2)(C).  

Since it's a Roth account, will she have to pay income taxes on a direct distribution, or will it be tax free? 

72(t)(C) provides that an exception to the imposition of the 10% penalty under 72(t)(1) includes:

"(C)Payments to alternate payees pursuant to qualified domestic relations orders: Any distribution to an alternate payee pursuant to a qualified domestic relations order (within the meaning of section 414(p)(1))."

So one would surmise that the 10% penalty will not apply to the Roth distribution.  

I guess she could take a loan or make a hardship withdrawals if she is disabled, or she can just wait until age 59-1/2. 

What do you think?  Any creative ideas? 

David

[Peter Gulia]

A QDRO distribution now (if the plan provides it without waiting for an earliest retirement age) might meet your client’s need for money.

That might be so if “about 90%” of the QDRO distribution is allocable to Roth amounts and the conditions for a Roth-qualified distribution are met.

About Federal income tax generally:

Even if a court order commands or an alternate payee requests an immediate distribution, a plan’s administrator first divides a participant’s account into the participant’s and the alternate payee’s separate portions, and sets up a segregated account for the alternate payee.

Unless the court order specifies otherwise (and calls for nothing contrary to the plan), a division should result in the alternate payee’s segregated account getting Roth and non-Roth amounts in proportion to the participant’s before-division account. See 26 C.F.R. § 1.402A-1/Q&A-9(b) (“When the separate account is established for an alternate payee . . . , each separate account [the participant’s and the alternate payee’s] must receive a proportionate amount attributable to investment in the contract.”). See also I.R.C. (26 U.S.C.) § 72(m)(10).

If an alternate payee is or was the participant’s spouse, such an alternate payee is treated as the distributee of a distribution paid or delivered from the alternate payee’s segregated account. I.R.C. (26 U.S.C.) § 402(e)(1)(A).

A distribution allocable to non-Roth amounts likely is ordinary income.

A distribution allocable to Roth amounts might be a qualified distribution not counted in income. I.R.C. (26 U.S.C.) §§ 402(d), 408A(d)(2)(A).

(Your description of the assumed facts does not say whether the participant completed a five-taxable-year period of participation in the designated Roth account, and does not say whether the participant is dead, disabled, or reached age 59½. See https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts.)

About the too-early tax:

“Any distribution to an alternate payee pursuant to a qualified domestic relations order (within the meaning of section 414(p)(1))” is an exception from the extra 10% too-early income tax that otherwise might apply to a distribution before a distributee’s age 59½. I.R.C. (26 U.S.C.) § 72(t)(2)(C).

About a payer’s withholding toward Federal income tax:

Whatever the withholding rate or instruction, a payer applies it to the portion of the distribution counted in income. “[A] designated distribution does not include any portion of a distribution which it is reasonable to believe is not includible in the gross income of the payee.” 26 C.F.R. § 35.3405-1T/Q&A-2(a)

Hyperlinks to sources:

Statute:

I.R.C. (26 U.S.C.) § 72 http://uscode.house.gov/view.xhtml?req=(title:26%20section:72%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section72)&f=treesort&edition=prelim&num=0&jumpTo=true.

I.R.C. (26 U.S.C.) § 402 http://uscode.house.gov/view.xhtml?req=(title:26%20section:402%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section402)&f=treesort&edition=prelim&num=0&jumpTo=true.

I.R.C. (26 U.S.C.) § 402A http://uscode.house.gov/view.xhtml?req=(title:26%20section:402A%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section402A)&f=treesort&edition=prelim&num=0&jumpTo=true.

I.R.C. (26 U.S.C.) § 408A http://uscode.house.gov/view.xhtml?req=(title:26%20section:408A%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section408A)&f=treesort&edition=prelim&num=0&jumpTo=true.

Executive agency rules:

26 C.F.R. § 1.402A-1/Q&A-9(b) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/section-1.402A-1.

26 C.F.R. § 35.3405-1T/Q&A-2(a) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-C/part-35/section-35.3405-1T.

Caution:

Nothing here is advice to your client, or to you.

[fmsinc]

Peter. 

My local (Montgomery County, Maryland) buddies agree with you even though none of them have ever seen a direct distribution from a Roth account.   Thanks for your help. 

David Goldberg