Undo QDRO distribution rollover to IRA

Ex-spouse was awarded by QDRO part of employee's 401k benefits. The plan was for spouse to pay the income tax and with the rest, buy the employee out of his portion of their equity in their house. After the QDRO was reviewed and found proper, a "tax advisor" told the ex-spouse to elect to rollover the awarded benefits to an IRA. The ex-spouse did so, only to later learn that to take the money out of the IRA, she'll face a 10% early withdrawal penalty on top of the income tax. The rollover to the IRA took place 40 days ago.

I've been contacted by the divorce attorney for the ex-spouse, in hopes of being able to remedy this and avoid the 10% early withdrawal penalty.

I do not know if it would work, but since it has been less than 60 days, can the ex-spouse cause her IRA custodian to return the funds to the 401k trust, and then take a payout of the awarded benefits directly from the 401k plan and avoid the 10% early withdrawal penalty?

Any other suggestions?

In almost every case an Alternate Payee who is to receive a share of a Participant's 401(k) in accordance with a QDRO entered by a Court has the following options:

(a) All or any part of the Alternate Payee's share can be rolled over tax free to an IRA or other eligible retirement plan [like a 401(k) for example - but check with the 401(k) Plan Administrator and make sure they will accept a rollover from a former spouse's account.  They may think that the intent is to roll over funds from the another account owned by the Alternate Payee, but that is not the case.]  Note that if the Participant's 401(k) account has both Traditional and Roth components, the Alternate Payee will  need to have two IRA accounts to receive the rollovers, one for the Traditional portion and one for the Roth portion. As a general rule, the Alternate Payee should not roll over Traditional account funds into a Roth account without first discussing potentially negative tax consequences with a tax accountant, CPA or financial advisor.  The amount rolled over to the Alternate Payee's IRA or other eligible retirement account will become taxable income when it is distributed in the future.   By law, Roth accounts cannot be rolled into Traditional Accounts and must be rolled over into another Roth account.  See "Note" below and attached IRS Rollover Chart.

(b)  All or part of the Alternate Payee's share can be paid out as a taxable "distribution" - a term of art. It will be subject to state and Federal taxes, but not to the 10% early withdrawal penalty regardless of your  age.  See IRC 72(t)(2)(C) and -  https://www.irs.gov/taxtopics/tc558 

and https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

But see the strange T.C. Memo. 2017-125, Summers v. Commissioner at -
https://scholar.google.com/scholar_case?case=4327573022055470859&q=T.C.+Memo.+2017-125&hl=en&as_sdt=20000006 that seems to suggest that an IRA can be exempt from the 10% penalty if transferred directly to the Alternate Payee pursuant to a domestic relations order as defined by IRC §414(p)(1)(B) which relates only to ERISA plans (I think) and not to IRAs. 

The Plan will explain the options for Federal and State withholding.  The amount withheld will be available when the Alternate Payee files his/her income tax returns for the year in which the distribution is made - just like W-2 withholding with respect to employment income.  Actual taxes may be more or less depending on the Alternate Payee's total income from all sources, deductions, filing status, etc.

Note: that if the Alternate Payee elects a tax-free rollover to an IRA, and a few months later decides that he/she really needs the money that was rolled over into the IRA for something important, the distribution at that point will be subject to state and Federal income taxes AND ALSO the 10% penalty if the Alternate Payee is under age 59-1/2.  If the Alternate Payee elects a tax free rollover to another eligible retirement account sponsored by, for example, a current employer.  the Alternate Payee may not be able to take a distribution unless and until the Alternate Payee's employment is terminated, for example, by retirement, resignation, discharge or death; although it might be possible to take loan equal to 50% of the vested balance in the account but not more than $50,000.00 - a  tax free transaction at that point in time. 

The foregoing is the information that I give to all of the clients for whom I prepare defined contribution plan QDROs. 

Unfortunately I think the election in J. Simmons's case cannot be revoked and that the Alternate Payee is SOL and should consider suing whoever suggested the two step unnecessary rollover.  IRS Rollover Chart.pdf  

This is what happens when attorneys who draft Marital Settlement Agreements and Judges who don't know the law enter Divorce Decrees try to use pre-tax retirement assets to adjust for post-tax assets such as the equity in the family home.   Assume for illustrative purposes  that in the J Simmons scenario the amount of the 401(k) to be rolled over to the Alternate Payee was $200,000.  Assume that the Alternate Payee wanted to retain the family home, that the equity in  the family home was $100,000, that there were no potential capital gains tax issues, and that the Alternate was to pay the Participant $50,000 for his/her interest interest in the family home.   All you have to do it solve for the following equation assumed a combined state and Federal marginal tax rate of 20% or whatever marginal rate can be computed  by a CPA or experienced tax preparer.  

$50,000 (post tax) = .80X

X = $62,500 (pre-tax)

Now just deduct $62,500 from the $200,000 due to the Alternate Payee = $137,00 rolled over or distributed  to the Alternate Payee and you are done. 

David

July 9, 2026