Cashing out retirement funds during divorce

On Behalf of | Nov 15, 2021 | Divorce, Property Division |

Past posts on this blog touched upon the fact that retirement accounts become subject to property division proceedings during divorce proceedings in Texas. If one was not the primary income earner in their marital home, they might find themselves in need of an immediate infusion of funds following their divorce. Thus, the news that they might receive a portion of their ex-spouse’s 401(k) funds may come as welcome news.

One’s next question may then be whether cashing out those funds is an option. Many with that question may subsequently hear that cashing out tax-deferred retirement funds prior to reaching the age of retirement (59 1/2 years) results in a significant tax penalty. Yet as is the case with many complex property division issues, this may not be entirely correct.

Cashing out retirement funds in a divorce

While yes, cashing out 401(k) funds early typically nets an early withdrawal penalty, divorce presents a unique scenario. Indeed, according to information shared by Kiplinger’s Personal Finance, a divorce allows one to take a withdrawal from a retirement account without a penalty. Therefore, their portion of their ex-spouse’s 401(k) might help them get the money needed to secure new housing or pay for vocational training (should spousal support not cover those expenses). One should keep in mind, however, that they will have to pay income tax on any disbursement you receive.

Weighing the pros and cons

An added income tax burden is not the only drawback to cashing out 401(k) funds during one’s divorce. Cashing out eliminates that potential for growth those funds may experience from investment returns and earned interest over time. A divorcee considering this action should thus ponder whether the immediate infusion of funds outweighs those financial sacrifices.