Estimating taxes in a QDRO

[AZ-Tax]

New client brought in their Qualified Domestic Relations Order (going through divorce). Client under 59-1/2 and will recieve 1/2 of 401K and 1/2 of Fixed annuity IRA. Client needs money so both will be cashed in and her attorney wants to know what tax bracket she will be in. I see quite a few variables here, congress, senate & president could enact some tax changes for 2012, my new client could loose her job, etc. Other then going off her numbers on her 2011 tax return to estimate her 2012 income tax rate, does anyone know of another way?

[Dusty2004]

That is all you can do

New client brought in their Qualified Domestic Relations Order (going through divorce). Client under 59-1/2 and will recieve 1/2 of 401K and 1/2 of Fixed annuity IRA. Client needs money so both will be cashed in and her attorney wants to know what tax bracket she will be in. I see quite a few variables here, congress, senate & president could enact some tax changes for 2012, my new client could loose her job, etc. Other then going off her numbers on her 2011 tax return to estimate her 2012 income tax rate, does anyone know of another way?

Use their 2011 tax return information unless your crystal ball works better than mine. I always tell people that is what I am using unless they know of a major change coming - like marriage, kids, etc.

Dusty

[ttbtaxes]

She may die too in 2012. No one can predict the future. I'd play off of known events and assume facts continue as best you know them today. You can update your projections as circumstances change.

I don't see any major legislative changes happening in 2012 that will impact 2012 tax planning with a split Congress.

[Gary2]

New client brought in their Qualified Domestic Relations Order (going through divorce). Client under 59-1/2 and will recieve 1/2 of 401K and 1/2 of Fixed annuity IRA. Client needs money so both will be cashed in and her attorney wants to know what tax bracket she will be in. I see quite a few variables here, congress, senate & president could enact some tax changes for 2012, my new client could loose her job, etc. Other then going off her numbers on her 2011 tax return to estimate her 2012 income tax rate, does anyone know of another way?

The value of these is often so very high that they force a higher tax bracket by themselves, independent of any other income. I can't imagine doing this without also strongly urging the attorney to discuss with client whether some of the funds should be rolled over into an IRA. This would depend on the ability to fairly judge the amounts needed this year, as well as the options available for dividing the proceeds into direct and rollover - perhaps by carefully using the 60-day indirect rollover approach. (I'm not sure about the options for rolling over an Annuity IRA; the choices may be even more limited.)

As others noted below, my original wording failed to take into account the QDRO exception to the 10% early withdrawal penalty. While it's common that the situation will make the choice easy (e.g. a debt that absolutely must be paid this year), it's also possible this could take some math. There could be a tradeoff between moving from 15% to 25 or 28% this year versus pushing some into next year, keeping the 15% bracket but adding the 10% penalty (and throwing in state tax issues), or even discovering that the money doesn't need to be taken out at all.

In many cases, it can be obvious that taking it all out now is the right decision. What I prefer to avoid is the case where the taxpayer rushes to a decision because it's simple and minimizes today's stress, when financially a different choice is worth a bit of extra thought.

[WhiteOleander]

If it is rolled into an IRA, the later distributions are subject to early withdrawal penalty if the t/p is not 59 1/2.

[Roberts]

Seems to me it's a little late for the attorney to be caring about the tax bracket if they've already negotiated a settlement. QDROs are routinely written AFTER the divorce is settled.

As was said, QDRO directed distributions from retirement plans avoid the 10% penalty for early distribution.

[Gary2]

If it is rolled into an IRA, the later distributions are subject to early withdrawal penalty if the t/p is not 59 1/2.

Excellent point. I'll edit my post to prevent misinterpretation.

For some reason, the QDRO exception is one for which I always have a mental block - perhaps because I don't think I've ever seen them done correctly.

[Burke]

From the original post, it appears when he says "both will be cashed in" that this may have already been done -- i.e, transferred into tax-qualified accounts in the spouse's name? If so, early distribution penalties will apply to a subsequent surrender or withdrawal . If the spouse elected to take what she needed in a direct payment, avoiding the 10% penalty ramifications, and rolled over the balance into a qualified account, it might minimize the taxable distribution for tax purposes, and postpone taxable income and the imposition of early withdrawal penalties to a later tax year.

[Roberts]

It says they brought in their QDRO, they WILL receive assets and they ARE going through divorce. I seriously doubt a 10% penalty will be applicable.