Divorce Finance Tips

Divorce Finance Tips

Divorcing Couples Can Avoid the 10% Penalty on Retirement Fund Early Withdrawal

When couples divorce, there is often a retirement fund that needs to be split. This can be anexcellent source for a down-payment on another house. Under normal circumstances, however, these funds are subject to a 10% penalty by the IRS for an unqualified “early distribution”, ifthe funds are disbursed before the participant is 59 1/2 years old.

In a divorce situation, there can be an opportunity to avoid the 10% penalty. Let’s say that Sarah and John are getting divorced, and Sarah is getting half of John’s 401k, worth $640,000. Sarah’s half is worth $320,000. If Sarah needs to take $100,000 in cash for a house down-payment, there is a special rule that enables her to take cash without having to pay the 10% penalty. In Sarah’s case, it saved her $10,000 in penalties A Certified Divorce Financial Analyst (CDFA™) can help your client take advantage ofthis opportunity. It is important to know that avoiding the 10% penalty is only available before the money is transferred to another account, so your divorcing client needs to be aware ofthe rules before a serious mistake is made. Remember though, that income taxes will still need to be paid on this distribution.

New Tax Law Concerning Turning Rentals into the Family Home

A new tax law regardingdivorce and rental property went into effectJanuary 1, 2009. Assume that Blondie and Dagwood were divorced in December 2008. Theyowned several rental properties. Blondie kept oneof them and she decides to move into the rental earlier this year. It used to be that if Blondie wanted to sell the house after 2 years, she could apply her full $250,000 exclusion against the gain. But now the IRS wants part of those capital gains taxes that were accrued during the time it was rental property, starting January 1, 2009.

Scenario #1: Blondie moved into the rental in December, 2008. She sells this property in March 2011. There is a $240,000 capital gain which she is able to wipe out with her $250,000 exclusion because the house was not a rental as of January 1, 2009.

Scenario #2: Blondie does not move into the rental, but continues to keep the property rented out as she wants the rental income. Four years later in 2013, she moves into the rental. Two years later in 2015, she sells this property. There is a $240,000 capital gain. She is only able to able to wipe out 2/6 ($80,000) of the capital gain with her exclusion. She will have to pay taxes on the remaining $160,000. She will also have to pay tax on depreciation recapture.

Kevin Worthley is an investment advisor representative of the Retirement Planning Company of NE, a Registered Investment Advisor, 1287 Post Road, Warwick, RI 02888. He is also a registered representative of, with securities offered thru, Cambridge Investment Research, Inc. Member NASD/SIPC. RPC and Cambridge are not affiliated. Kevin can be reached with questions or comments at (401) 453-5558.