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Beware of pitfalls when splitting retirement accounts

Some Pennsylvania couples who are getting a divorce might be tempted to try to do it themselves. However, this could be a problem if there is a retirement account that needs to be divided. There could be significant taxes and penalties if it is not done correctly.

For example, a document known as a qualified domestic relations order is necessary for avoiding taxes and penalties on a 401(k). One person took $250,000 from a 401(k) for the other spouse without a qualified domestic relations order. Between the early distribution penalty of 10 percent and the tax rate of 39.6 percent, the withdrawal cost $110,000. There would have been no penalties or taxes if they had used a QDRO and moved the money into another retirement account. Different pension plans may have different sets of rules that must be followed in order to avoid penalties and taxes. In some cases, it may be necessary to dig deep into finances to discover old retirement accounts.

People should sign any documents, particularly the QDRO, before the divorce is final. If the person with the retirement account dies after the divorce and the paperwork is not complete, the other spouse may not get anything. A couple might also decide that they will split property in some other way instead of dividing a retirement account.

If this is the case, people should make sure they understand whether or not they will be taxed on withdrawals from the retirement account, making its actual worth less, or if they are taking another asset in return that could cost them. In a high-asset divorce, this could become particularly complex with multiple investments and other assets. People should keep in mind that an asset such as a home could be costly in terms of taxes, upkeep, insurance and a mortgage.

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