Sometimes people who are going through divorce think that they can avoid preparing a QDRO to divide a defined contribution plan (like a 401(k)) simply by taking the money out of the plan and giving it to their soon to be ex-spouse. When that happens, the Plan Participant will be taxed on the money they take out as it will be counted as income and taxed at normal income tax rates. If the Participant is less than 59 1/2, then there will also be a 10% tax penalty. The receiving spouse will pay no tax on the money they receive.
What happens when you transfer or receive the funds via a QDRO?
If you are to receive a part of a defined contribution plan (eg 401(k)), once the Plan receives the Court-approved QDRO, the Plan will set up an account for you and transfer your portion of the funds into your account. If you leave it there, or transfer it to an IRA or another similar retirement plan, then you will not pay any tax.
If you want to take out cash from the funds you are receiving via a QDRO, and you are younger than 59 1/2, then you can get the cash without the 10% early withdrawal tax penalty if you take the cash BEFORE transferring the funds to another qualified retirement account. If you, for example, transfer the funds to an IRA, and then take out the cash you want, you will be subject to the 10% tax penalty. Of course, the cash that you take out is still subject to income tax rate and is counted as income for tax purposes.
If you are over 59 1/2, then you are not subject to the early withdrawal tax penalty.