EXAMPLE:

Mary is 52 years old, did not work during the majority of the marriage and received the following:

* Marital home with a liability of $85,000

* Charge card debt of $5,000 at 22% interest

* 50% of her husband's 401(k) which had a value of $315,000 ($157,500 is Mary's portion)

* Alimony: $1,200 per month

Her husband received all the investment and cash accounts, his pension and 50% of his 401(k) and $5,000 in debt. Mary has to refinance the house to remove the former Husband from the mortgage obligation. How is Mary going to re-finance and pay off the charge card debt? How is she going to qualify for a mortgage if she is only receiving $1,200 per month in alimony?

No QDRO distribution taken: Here is what could happen if she did not take a QDRO distribution:

* Mary would have to wait several years to save enough money to re-finance the home

* During this time, Mary would have to continue paying the current mortgage payment, which would be higher than a re-financed payment

* Mary would have to make the minimum payment of $126 a month to have the $5,000 charge card debt paid off within 6 years

* Mary would have paid a total of $4,045 in interest on the charge card debt

* Mary's tax liability from the alimony would only be $626

Taking a QDRO distribution: Here is what could happen if she took an early withdrawal from the 401(k):

* Mary's tax liability would go up from $626 to $3,176 in the year of the withdrawal

* However, Mary would save $4,045 in charge card interest over 6 years (a savings of $869)

* Mary's QDRO distribution would automatically withhold 20%. Therefore, if Mary took a distribution of $17,000, she would have automatically paid $3,400 in federal tax withholding. She could possibly receive a refund of $224.

* Mary could invest the monthly payment of $126 that was going towards charge card debt in a mutual fund over 6 years. Assuming a conservative 5% rate of return, Mary's monthly investment savings would have grown to a savings of $10,554 over 6 years

SUMMARY: Although Mary would initially have a higher tax liability due to the QDRO distribution, she would have considerable savings over the long run. Her 6 year savings would be as follows:

* Charge card interest: $ 869

* Tax refund: $ 224

* Investment: $10,554

TOTAL SAVINGS: $11,647

As you can see, the benefit of taking the withdrawal and paying the tax benefits Mary in the long run. It is important to have your client do divorce planning prior to going to settlement. This will help you, and the client understand what the best division of assets will be for the client in the long run.

How does this exception benefit the Participant? If both the Alternate Payee and the Participant are in need of cash and want to take advantage of the penalty free withdrawal, the settlement agreement can be written to allow the Alternate Payee to receive all or a portion of the retirement plan, state that the Alternate Payee will take a distribution and give the Participant their tax effected share of the distribution. This benefits both parties if they are in need of cash. Additionally, if the Participant will be in a higher tax bracket than the Alternate Payee after the divorce, the distribution will be taxed at the Alternate Payee's tax rate, which will save taxes.

Remember, a distribution under this rule can only be done from an ERISA covered retirement plan that has been QDRO'd. This rule does not apply to IRA distributions. Therefore, if a client QDRO's their awarded benefits, rolls it into an IRA and then takes a distribution, the 10% penalty will apply to the distribution. The client has to take the distribution prior to a rollover into an IRA to be exempt from the 10% penalty.

We can complete a distribution analysis for you and your clients prior to settlement if they want to know what the estimated tax liability will be or if an early distribution will benefit the in the long run.

Janen Moyer & Co. does offer clients a free distribution consultation as part of the QDRO fee. The distribution consultation offers your clients the ability to see how the distribution will affect their tax liability, potential future savings and whether a distribution is in their best interest. Call our office if you would like to have a QDRO distribution analysis done prior to settlement.

Starting in January, we will also be covering creative divorce planning strategies, in addition to our QDRO Quick tips!