This is where you are losing me. Can you give an example (and maybe several examples would help clear things up) of where retirement funds are withdrawn in connection with a divorce settlement with no tax penality???
I would appreciate a straight forward, non-double talk answer from you.
Ok...someone has a 401k with company B for 100k.
The court orders that the spouse gets 50% of the 100k, however the company's plan will not accomodate the account being split into two different accounts, (which would be unusual) therefore 50% of the money has to be withdrawn from the account and given to the spouse by check.
That creates a taxable event for the original holder of the 401k, but per the tax code the 10%
early withdrawal penalty is waived. The person files form 5329 with their tax return and chooses exception number 6 on line 2.
Second example
Same scenario however the company's plan allows for the original 401k to be split into two separate accounts. One for the original account holder and one for the spouse.
The spouse then decides to withdraw the money from the account and close it....or perhaps even the company plan requires her to do that.
That means that the 1099-R will be issued in HER name, rather than in the name of the original account holder, and she would be responsible for any taxes, but again, there will be no 10% early withdrawal penalty and form 5329 should be used. However, that only applies in the year of the divorce. If she leaves the money in the account or rolls it over into another account and then withdraws it several years later, there would be a penalty.
In both scenarios they have to pay regular income tax on the withdrawal (which they would have to do even after they retired), but there is no penalty.
Bali,
If you had this happen, and you got a 1099-R, and you did not include form 5329 with your return (choosing exception number 6), then you can still amend your return to get the penalty money back, as long as it wasn't an earlier year than 2004.