Posted on December 15, 2021

Cashing Out 401(k)s And Other Retirement Accounts During An Illinois Divorce

Divorce attorney see their clients and their client’s spouse’s true finances. The truth is that most people have little in the way of assets outside of their marital home and their retirement accounts.

When a divorcing couple’s assets are tied up in a home and retirement accounts, the divorcing the parties must pay for their new expenses: two households and two divorce lawyers (and possibly a Guardian Ad Litem) out of their current incomes.

When the incomes are not sufficient and there is no additional source of savings, there are only two other places to get the money necessary to support two households: the house and the retirement accounts.

One spouse will be living in the marital home. That spouse will be reluctant to sell the marital home to pay expenses and the parties certainly won’t take a marital loan out against the house to pay expenses. A marital home will not be sold without a court order…and the proceeds from that sale won’t be available for months.

That leaves the retirement accounts as the only source of cash for the parties.

Are You Allowed To Withdraw Or Borrow Money From Your 401(k) During A Divorce?

Yes. There are no restrictions on anything regarding money just because a divorce was filed. In fact, any automatic restriction on a person’s money “exceeds constitutional bounds for violation of the guarantee of substantive due process.” Messenger v. Edgar, 623 N.E.2d 310 (Ill. 1993)

If you want a retirement account to be frozen or forbid either party making a withdrawal or encumbrance against said account during the pendency of a divorce, you’re going to have to file a motion.

A motion to freeze an account will request that the court issue an order “restraining any person from transferring, encumbering, concealing or otherwise disposing of any property except in the usual course of business or for the necessities of life” 750 ILCS 5/501(a)(2)(i)

Without such an order, the parties are free to withdraw or borrow against their retirement accounts.

Withdrawing money from a 401(k), 403(b) or IRA During An Illinois Divorce

The incentive of a qualified retirement account is to allow deposits into the account to be tax-deferred. The tax-free deposits will grow faster and be larger after the eventual taxes are paid upon withdrawal.

There is also a disincentive to withdrawing funds from a qualified retirement account.

“If any taxpayer receives any amount from a qualified retirement plan (as defined in section 4974(c)), the taxpayer’s tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is includible in gross income” 26 U.S. Code § 72(t)(1)

Of course, sooner or later, the retired must withdraw from their retirement accounts. This 10% penalty tax is removed upon reaching age 59 ½.

“[The 10% penalty] shall not apply to any of the following distributions:

Distributions which are—

  • (i)             made on or after the date on which the employee attains age 59½” 26 USC 72(t)(2)(A)(i)”

This 10% tax penalty could be interpreted as a dissipation of assets and reduce the party withdrawing the money’s final allocated marital assets by an equivalent amount.

Furthermore, if the money withdrawn is not used for a legitimate purpose the other funds may be considered a dissipation of assets as well.

“Dissipation is defined as the use of marital property for one spouse’s sole benefit for a purpose unrelated to the marriage at a time when the marriage is undergoing an irreconcilable breakdown.” In re Marriage of Tietz, 605 NE 2d 670 – Ill: Appellate Court, 4th Dist. 1992

Borrowing Money From A 401(k) Or Other Retirement Account During An Illinois Divorce

To avoid paying the 10% penalty, a 401(k) participant may instead borrow against the value of the 401(k)…to a certain extent.

Loans against a 401(k) are treated as distributions and subject to the 10% penalty.

“If during any taxable year a participant or beneficiary receives (directly or indirectly) any amount as a loan from a qualified employer plan, such amount shall be treated as having been received by such individual as a distribution under such plan.” 26 CFR 72(p)(1)(A)

An exception will be made for loans lower than $ 50,000 less any other other loans that were made not to exceed half of the value of the total 401(k).

“[It shall not be considered a distribution subject to the 10% penalty if the loan ]does not exceed the lesser of—

(i)$50,000, reduced by the excess (if any) of—

(I) the highest outstanding balance of loans from the plan during the 1-year period ending on the day before the date on which such loan was made, over

(II) the outstanding balance of loans from the plan on the date on which such loan was made, or

(III) the greater of (I) one-half of the present value of the nonforfeitable accrued benefit of the employee under the plan, or (II) $10,000.” 72 CFR (p)(2)(A)

This new debt will likely remain the responsibility of the party accruing the debt when the court allocates marital property.

“”marital property” means all property, including debts and other obligations, acquired by either spouse subsequent to the marriage” 750 ILCS 503(a) (emphasis mine)

Of course, the ability to cash in or borrow from a 401(k) or other retirement account is only within the power of the spouse who the 401(k) or other retirement account in their name. To get access to this cash when your spouse controls the retirement account requires an order from the divorce court.

Court Ordered Distributions From A 401(k) Or Other Retirement Account During An Illinois Divorce

Illinois divorce courts can make temporary orders in relation to the party’s present assets during the course of an Illinois divorce.

An Illinois court can order “appropriate temporary relief including, in the discretion of the court, ordering the purchase or sale of assets and requiring that a party or parties borrow funds in the appropriate circumstances.” 750 ILCS 5/501(a)(3)

However, retirement plans are exempt from court orders.

“A debtor’s interest in or right, whether vested or not, to the assets held in or to receive pensions, annuities, benefits, distributions, refunds of contributions, or other payments under a retirement plan is exempt from judgment, attachment, execution, distress for rent, and seizure for the satisfaction of debts” 735 ILCS 5/12-1006(a)

There are only two reasons a retirement account would need to be accessed before a divorce is finalized: 1) Maintenance and/or child support or 2) Interim Attorney’s Fees.

In the case of maintenance or child support, the retirement account can be accessed to pay those moneys owed for those purposes.

“[W]hen a former spouse seeks the assignment of the plan participant’s retirement accounts after obtaining a judgment for a maintenance and child support arrearage, the spouse is not a typical creditor as that term is used in section 12-1006.” In re Marriage of Thomas, 789 NE 2d 821 – Ill: Appellate Court, 2nd Dist. 2003

Still, the 10% penalty will accrue when the money is accessed. A court will be inclined to divide the assets in a final judgment for dissolution of marriage which will allow for the entry of Qualified Domestic Relations Orders(QDRO) awarding the spouse owed child support or maintenance any additional moneys owed. This way, the spouse owed child support or maintenance can withdraw or borrow against their own newly awarded account without their former spouse’s permission.

Retirement accounts cannot be accessed to pay interim or final attorney’s fees, however.

“[W]hile retirement accounts are not exempt under section 12-1006 from judgment for support orders, they remain exempt for orders pertaining to attorney fees.” In re Marriage of Radzik and Agrella, 955 NE 2d 591 – Ill: Appellate Court, 2nd Dist. 2011

Illinois divorce courts cannot “order[] the liquidation of [a] 401(k) to pay interim attorney fees.” Shen v. Shen, 35 NE 3d 1178 – Ill: Appellate Court, 1st Dist., 3rd Div. 2015

The logic of not allowing retirement fees to be tapped by the courts is as follows:

“[T]he interim fee system’s purpose of seeking to level the playing field when one party uses his or her greater control of assets as a litigation tool is not served by liquidating a retirement asset that even respondent could not use in the litigation. While the IRA is an asset that will be distributed in the final disposition of the marital estate, respondent was not during the litigation drawing any funds from the IRA. In other words, where the IRA benefitted neither party in the litigation, forcing its liquidation and distribution did not serve to counter respondent’s use of an asset because, by virtue of the account’s very nature, respondent could have no expectation of accessing it.” In re Marriage of Radzik and Agrella, 955 NE 2d 591 – Ill: Appellate Court, 2nd Dist. 2011

A retirement fund was not designed to be a slush fund. An Illinois divorce court will not treat a retirement account as one for the purposes of extending litigation between the two parties.

But, if money was withdrawn from a 401(k) or other retirement account or borrowed against a 401(k) or other retirement account…it no longer enjoys 735 ILCS 5/12-1006(a) protections and can be accessed by the courts.

So, if you take a cookie out of the cookie jar…be prepared to share it.

Divorce is difficult. Taxes are difficult. Finances are difficult. Mixing the three is really difficult. When you need to access tax deferred accounts during an Illinois divorce, you need a professional to ensure you’ll have access to those accounts with minimal tax and penalty exposure. Contact my Chicago, Illinois family law firm today to learn more about all of your options to access (or protect) tax deferred accounts.

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Russell Knight

Russell D. Knight has been practicing family law as a Chicago divorce lawyer since 2006. Russell D. Knight amicably resolves tough cases while remaining a strong advocate for his client’s interests.

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