General Tax Rules for Withdrawal from a Retirement Plan
Whenever a plan Participant (such as an employee with a 401(k)) withdraws money from a retirement plan, income tax must be paid on the amount withdrawn. If the Participant is younger than age 59.5, usually a 10% early withdrawal penalty must also be paid. This includes the withdrawal and transfer to a spouse or former spouse. And the Participant cannot even do the withdrawal until after the employment is terminated (unless a QDRO is done.)
If a plan Participant withdraws retirement plan cash and transfers that money to a former spouse pursuant to a divorce, the plan Participant has to pay the income tax on the withdrawal, as well as the 10% early withdrawal penalty if it applies to the withdrawal. The tax effect is the same as if the withdrawal was done without any divorce proceeding.
However, note that a Participant cannot take a cash withdrawal if he or she is still employed by the plan sponsor. He or she can take a loan only if it can be repaid with payroll deductions.)
The same rules apply to the transfer of an IRA. Except that all cash withdrawals from an IRA are subject to the 10% early withdrawal penalty. An IRA withdrawal does not get the same exemption from the 10% early withdrawal penalty that a withdrawal from a qualified retirement plan gets.
You don't want the additional financial burden of an unnecessary income tax at the time of the divorce.
The QDRO "No Income Tax" Advantage
When a QDRO is used to divide retirement plan assets between former spouses pursuant to a divorce proceeding, the division is done tax-free.
The plan Participant (employee) pays no income tax.
The former spouse (Alternate Payee) who is receiving the retirement plan benefits will pay income tax at the time of the later withdrawal from the retirement plan.
The QDRO 10% Early Withdrawal Penalty-Avoidance Advantage (Avoid IRA Rollover)
If done correctly, that former spouse (Alternate Payee) who receives the QDRO account can withdraw retirement benefits received through a QDRO without having to pay the 10% early withdrawal penalty. However, the 10% early withdrawal penalty can be a tax trap if the withdrawal is not done correctly. For example, if the former spouse rolls the separated retirement assets into an IRA and then withdraws the money from the IRA, that withdrawal is subject to the early withdrawal penalty laws. So - be careful about how you structure a withdrawal from a QDRO division of a retirement plan.
Avoid the use of a "financial planner" because he or she will always advise the Alternate Payee to roll the QDRO account money into an IRA. The reason for this advice is so the "financial planner" can earn commissions on the IRA money. (No commissions can be earned on the QDRO account when it is still held by the plan administrator.) Then when a cash withdrawal from the rollover IRA is taken, the 10% early withdrawal penalty will be incurred.
For further information, see the page on costly QDRO mistakes.