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I have two retirement accounts that will both get split after my divorce that just got finalized. One is a Roth IRA, the other a 401(k) account.

Is it possible to cash out money because of the divorce without paying the penalty ?
What are the taxes that need to be paid on both ? Do I have to pay capital gains on the growth in the Roth ? Assuming everything I bought is over a year old, is it long-term capital gains ?
Do I need to pay capital gains on the growth in the 401(k) ? Do I just pay income tax on the whole amount ?

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    Are you asking about simply splitting the accounts (so each of you ends up with an account), or actually cashing them out - closing the account and taking the money? – jamesqf Nov 17 '20 at 17:27
  • I don't have questions about the split itself. I know that that's not a taxable event. I'm wondering about cashing out the half that I get to keep – xyious Nov 17 '20 at 22:46
  • The divorce doesn't affect the rules for retirement plans and none of the capital gains provisions (rates and holding periods) ever apply. For a Roth IRA you can take contributions (treated as taken first) anytime; if you take earnings before age 59.5 or before having the account 5 years (or conversions within 5 years) you pay ordinary-rate tax on that portion plus 10% penalty. For a trad 401k (or IRA) without post-tax contributions (the usual case) you pay ordinary-rate tax on the full amount always, and 10% penalty if under 59.5. – dave_thompson_085 Nov 18 '20 at 7:30
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You should not have to pay any penalties, if you file the paperwork correctly. See for example this Investopedia article; there are some important details to get right to avoid paying tax and the 10% penalty. You end up doing a kind of rollover transaction. If the money is all pre-tax, or all post-tax (Roth), then it's easier; if the accounts are mixed, then it's more complicated, as you need to track the basis and file more forms (with the IRS).

This is the kind of thing you should talk over with your attorney (and they should know them well), and probably consider getting a CPA to help make sure this transaction is done properly, particularly if your accounts are very large.

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  • I do know that I don't have to pay taxes on the splitting of the account but does that also apply to withdrawing funds ? – xyious Nov 17 '20 at 17:26
  • I did not file the paperwork correctly on one of my "young" Roth accounts, and had to pay a penalty. – RonJohn Nov 17 '20 at 17:44
  • @xyious "does that also apply to withdrawing funds ?" Why shouldn't it? – RonJohn Nov 17 '20 at 17:44
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    @RonJohn Because it's an investment vehicle made of special laws, rules, and conditions? For a non-expert, "I feel like it should work this way" is not a very useful position, especially when that person is aware that they are not an expert. Hence StackExchange. If it's as simple as "why shouldn't it?", then the answer is just "yes". – Upper_Case Nov 17 '20 at 21:36
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    @RonJohn That second sentence a much more helpful response, especially as my read of "why shouldn't it" as a response suggests the opposite conclusion. If you're familiar enough with the relevant law(s) to be able to confidently make that statement, you wouldn't be asking the question. I'm not meaning to criticize, just mention that (to me) the comment seemed unclear and primarily useful to someone that already is confident in their understanding of topic. – Upper_Case Nov 17 '20 at 21:52
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https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-answers

Section 2202 of the CARES Act changed distribution rules:

In general, section 2202 of the CARES Act provides for expanded distribution options and favorable tax treatment for up to $100,000 of coronavirus-related distributions from eligible retirement plans

You are a qualified individual if –

You are diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention; Your spouse or dependent is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention; You experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19; You experience adverse financial consequences as a result of being unable to work due to lack of child care due to SARS-CoV-2 or COVID-19; or You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.

This expires on 30-Dec-2020, though.

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  • Yeah, CARES act doesn't apply to me. I'm still working and getting paid as much as I was before and I didn't have any additional expenses. – xyious Nov 17 '20 at 22:48

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