The 401(k) Cash-Out Process 

Whether you work for a private company or a federal, state, county or city agency, you and your spouse can free-up 100% of the money in that retirement plan to invest as you desire, either on a taxable or tax deferred basis, without paying the 10% early withdrawal penalty assessed on persons under 59½ years of age. 

All benefits contributed and/or paid into a qualified retirement plan during a marriage are community property of the married spouses. The Texas Family Code allows married couples to change the character of their marital property from community to separate property by entering into written agreements that is called a partition agreement. Retirement plan benefits can be recharacterized in this manner without affecting any of the remaining community property of a marriage. As much as 100% of a retirement plan can be changed into the separate property of the non-participating spouse. 

An order called a qualified domestic relations order (“QDRO”) must be obtained from a state district court approving the partition of the retirement account and directing the plan administrator to transfer the money from the participant’s account into an account in the name of the participant’s spouse, referred to as the “Alternate Payee”. Upon receipt of a certified copy of the signed QDRO, the plan administrator creates the separate account and transfers the money in accordance with the terms of the QDRO.

The Alternate Payee can then take control of the money in one of three ways: (1) Cash Distribution. The money can be withdrawn, just like from a bank withdrawal. If withdrawn, the plan administrator is required to withhold 20% of the withdrawal for federal income taxes. The full amount of the distribution must be included in the married couple's taxable income for the year of withdrawal. No 10% early withdrawal penalty is assessed on a distribution pursuant to a QDRO. Once withdrawn, the money can be used for self-directed investment purposes. (2) Rollover to an SDIRA. Alternatively, the money can be transferred (“rolled over”) to a self-directed IRA (new or existing) in the name of the Alternate Payee and invested from that account.  The rollover incurs no tax liability and no tax is paid on the IRA earnings until money is withdrawn. (3) Combination of Cash Distribution and Rollover. Depending on the married couple's income tax situation, part of the money could be withdrawn and the remainder rolled over to an IRA. 

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