Next Level 269: The 401(k) Loophole Most Couples Will Never Hear About

We were able to go and take over a million dollars out of his pension, not his 401k out of his pension, let his wife convert that to a lump sum IRA rollover, and then start doing the Roth conversions, literally from his pension.

Wow. Welcome to the Next Level Income show where it's our goal to take your income, your investments, and your life to the next level. I'm your host, Chris Larson. If you haven't yet, get a copy of our book for free at our website, Next Level Income.com. that's www.nextlevelincome.com. just click on the book link and I'll even send you a copy if you put your address in. On today's show, we have Marcus Foote. We're going to be diving into a really interesting 401k loophole called the In Marriage Quadro. Marcus is a partner at Kuhn and Foote aplc, where he focuses exclusively on community property divisions, military divorces, and qualified domestic relation orders. Also known as Quadros, Marcus also serves as a consultant for attorneys throughout Louisiana, advising in niche areas of community property and strategic planning, retirement plan valuations, preparation of retirement division orders, and military pension benefits. In 2013, he developed a process that would ultimately become known as the In Marriage quadro. And since 2018, he's been successful in executing these in 34 states. Today, we're going to dive into what the quadro is, who can benefit, and how you can learn more. Marcus, welcome to the show.

I appreciate it.

Nice to have you. Yeah, it is. Yeah, it's great to have you here and I'm excited because this is a topic that I personally want to learn more about. And I think the audience probably have your attention here. Today we're going to be talking about the In Marriage Quadro. And there's, you know, what's interesting to me, I love the tax code. You know, some people are scared of the IRS and the tax code and, and I like to see it as a rule book. And today we're going to talk about one of the IRS rules that, you know, investors, people can take advantage of. But before we jump in here, Marcus, I'd love for you to share a little bit about, you know, your background and before we start talking about what, what the quadro actually is, I'm a.

Board certified family law attorney, so I've been doing, you know, divorce litigation since the late 90s. I realized that quadros and retirement division, military division, things of that sort, was an untouched task. So I started kind of specializing in that, doing consulting with other attorneys around Louisiana. And so I started doing a lot of quadros for divorces parties. And I literally was sitting at a restaurant with a financial advisor friend of mine. We were just talking and chit chatting and an idea, he made a comment and literally at a bonefish grill, came up with the concept of, why can't you do the same thing for divorce, for married parties that I'm doing for divorcing parties to be able to transfer and control the funds better? And that kind of literally how the whole epiphany concept of the marriage quadra came up.

All right, so I think we should define what is a quadro. We're saying quadro, and I love somebody was saying qdro. I said, you could just say quadro. What does quadro stand for?

It stands for qualified domestic relations order. So in the divorcing set point, when you have a property settlement after divorce, if the husband has 600,000 in his 401k or the wife has money in her 401k or 403, it's how to get from one party to the other party without it being a taxable transaction. And you got to meet all the requirements of the ERISA code and tax code and things of that sort. So it's kind of a niche that not every family law attorney gets into because of all the extra requirements and things of that sort. And so the in marriage quadro has been able to come up with a spousal contract that triggers the same federal statute in order to get access to the forms.

Gotcha. So this, this is traditionally, just so I in the audience understands, traditionally, this has been a tool used for couples that are in a divorce. Right?

Correct. I would think prior to. When I started doing some of this, around 2016. I don't. If you googled, I don't think you would have found a single example of. Of it being done during the marriage.

Yeah. So what, you know, what did you figure out within the tax code that allows this to be used for couples that are. That are actually still married? What's the, like, what's the nuance there?

I googled the definition of alternate payee while I was at that restaurant, and it said the definition. And I've seen this definition for 15 years, like, every single time I did a quadrant, you know, 2,000 times prior to that. But it said alternate pay is a spouse, comma, former spouse. Well, former spouse is the one that you're divorced from. Spouse or current spouse.

Yeah.

And so that was kind of like the first seed. And then I just started doing a bunch of research, did them only with one advisor in Louisiana with local clients for two years, went through two tax cycles, make sure there were no bugs. I wasn't missing anything. And, you know, after 30 of them, I was like, maybe, maybe we can start a business doing this wider. So I started kind of contacting other people and going from there.

Well, obviously it's positive for business, right? Cause there's more clients out there. But I gotta say, it's gotta be more fun to help people that are still married, you know, take advantage of a positive financial situation than dealing with it on the other side. Right?

That's exactly right. Yes.

Yeah. Wonderful. So, all right, so we've talked about what a quadro is. I guess, you know, the big question is like, why. Why would anybody consider doing this? I will say, let me, let me back up a little bit. We talked a lot on the podcast over the past several years, and I've not been shy about this. I'm not a huge fan of 401ks. And, you know, if you do the math, I think, you know, a lot of, a lot of investors don't understand that if, if you, if you put your Money in a 401k, you save tax today. So if you are paying a 25% effective tax rate today, actually it'd be marginal tax rate technically. So let's just use 25% and you put your money in a 401k and you earn 10% and you take it out tax free. You have a certain amount that you can take out after, say, 20, 30, 40 years. But if you paid that same amount of tax today and it accumulated at 10%, and then you didn't have to pay tax in that 20, 30, 40 years, it ends up being the same amount of money. So the bet that you're making when you put money into a 401 is that your tax rate in the future is, is going to be lower than your tax rate today. So I always like to ask investors, you know, do you think you're going to be poor, you know, in the future or not? And some people say, yeah, my tax rate is going to go way down, you know, But a lot of people, especially successful business owners, people that have been successful investing, they say, well, I don't, I don't know. And I don't think the tax rate is going to go down. I don't think it can. Like, we actually need to raise taxes about 4,50% just to balance the budget today, you know, so if, if your Answer is no, I don't think I'm going to be paying less taxes in the future. It might not be a great decision to put Money in your 401k. You know, the other disadvantage is you've got to wait until you're 59 and a half and I've got to.

They're just more contingencies, they're just more.

There'S all these, there's all these rules. So I guess, you know, I, I'm kind of answering the question ahead of time, but why would somebody want to go through this process in the first place?

I mean, I can give you probably the top two or three. The first one, the first financial advisor that I was telling you about when I came up with the idea, he did alternative investing. So he was one that would start putting funds from a 401k into a self directed IRA and buying real estate or buying, you know, these, you can buy credit, you can buy debt, you can do, you know, gold alternative investing. Now some people like that, some people don't like that. But you couldn't do it without doing the emerge quadro getting funds. So that's one. The other way, which is probably the most common is if you have an older spouse and that, that will be eventually that married to a younger spouse, you could take funds from your 401k and roll it down into the IRA of the younger spouse, say 6, 7, 10 years. And it delays the RMD strings.

Oh, interesting. So let's, let's dive into that a little bit. So you're saying, so let's say you have somebody that is, you know, 60, that marries somebody that's 40, for instance, and they're both, you know, they both have, you're saying they both have 401ks or IRAs. Is that, is that a good or.

Just one of them or just the older.

Oh, just the older. Okay. So what you're saying is you could actually take those funds and move them in between IRAs or 401ks.

It's not RAs, right? Move it from the older spouse's 401k to the younger spouse's IRA.

Oh, interesting.

So let's say, well, when I started this, the RMD age was 70, now it's 72 and something. But let's say they're 67. Well, in three years they're going to be having to pay it. So let's say they're married to somebody that's 55. They can roll it down and delays it for 18 years.

Yeah, no, I like that. And I'll give you a personal example. My stepfather is going to be 72 here shortly after this podcast airs, and he has multiple other sources of income. Annuity, rental income, you know, some other stuff. So if he took his required minimum distributions today, he's going to get income that he doesn't need at the moment, but he's going to have to pay tax on that income. So you're saying that, you know, someone like that could move that money down to their spouse, delay the RMDs and delay the taxes and basically keep that money growing, but spread out the income over a longer period of time?

Correct, Correct.

That's a, okay, terrific. That's, that's something I didn't, didn't even realize.

And then the third, the third primary reason that people do it is to get it to take advantage of the exemption. Most people, if you have 10 people and say, look, I'm 48 years old, I'm 52 years old, and I want to take money out of my 401k, they're going to say, oh, you're going to be, you're going to be penalized the 10% early withdrawal penalty. Well, divorce attorneys, specifically quadro divorce attorneys, have been utilizing an exemption in the IRS for 30 years where you don't pay the 10% penalty even if you liquidate before age 59 and a half.

Okay. So we're really going to dive into that. So how does, how does that work?

So again, for, again, in, in, in divorce cases, you would do like, you know, a lot of times sometimes people have debts when they finish divorces or you got to finance, you know, those taxes. Terrible family law attorneys, you know, and stuff like that. Right. But, but you can get access or they're just starting over. Right. They have to buy a second house or whatever. Yeah, well, when you, when you have it, you can actually liquidate from the quadro and, and not pay the 10% penalty. You pay the tax because it's pre tax, but you don't pay the 10% penalty. And if there's Roth, you don't even pay the tax inside of the 401k. Right.

Say that one more time.

And if there's Roth component or an after tax component, you know, extra big down in Louisiana. Right. So some of them have after tax income or after tax. And so if you can do it for divorcing part, which we've been doing for 30 years, to kind of help people get started again after divorce, it's the same exemption for a marriage quadra. So you literally can do this, get the funds, pay the tax or do a tax withholding. You don't pay the 10% early withdrawal penalty.

I love that. So going back in reverse, you can, you can move funds, not pay the 10% penalty. You can move funds from one spouse to the other and spread out your income over a period of time. Yeah.

And you can actually do it. You can do it in two seasons. We did one up in Washington a couple of years where they, they wanted to liquidate multiple hundreds of thousands. We did one in marriage, Quadro in, started in October, liquidated it in December, started another one in December, liquidated it in January. So it was divided into two tax seasons, but within six, within, you know, 12 weeks, three months, he had liquidated multiple hundreds of thousands of funds. Now he paid taxes, but, you know, that's his own. That's to get with his cpa. I don't give financial advice or tax advice. But he, he had plans for it. And of course it just coincidentally was that company and his company, public company. The stock went down. It was right before 2022. So in addition to doing that, he had just lucked out because the stock tanked right after that when the 2022 stock market started to go down. And he ended up saving a ton of money by, by liquidating it.

Yeah, that's, that's fascinating. So, yeah, I think we, you definitely got a lot of people's attention here. I'm sure some are thinking like, okay, this sounds great, like, you know, almost too good to be true. What are, what are some of the downsides that you've seen? Marcus, you said you, you stress tested it for a couple years. Has this, has this been litigated in tax court? Like have we seen.

No, it is not. Because it there. Because it's agreed one, it wouldn't be litigated in tax court. There is. I can give you all our statistics. We probably get about, I think right now our statistics about, about 93% of them are approved by the judges. And you say, well, which one? Well, every once in a while a judge, because it's so niche, say I don't have jurisdiction now. I think they're wrong. But we've come up with a policy where we refund a majority of the client's money because you're just not going to convince the judge. Right. And, and this is not an acrimonious situation. So you're not going to want to appeal or challenge the judge or, you know, so if we're batting 93% from a business perspective, for us it's easier just to refund one out of every, you know, 14 clients money and just fund their money so that they don't have upset people.

Gotcha. Gotcha.

So there's not going to be a tax litigation.

Gotcha. Okay, so you're not, you're not going to increase somebody's risk of audit or something like that if you're.

I can't. I mean, I. It's been now since 2014 and I've not had heard a single person get an audit. So it's possible theoretically, but I can't see why.

Gotcha. Interesting. Okay. But there is, there is a chance that this, so this has to go. Just so I understand, this has to go past the judge for a thumbs up.

Got it. It has to be signed off by a judge. And so the, the really, the only big risk is this is an actual transaction. Right. So if, if one party's transferring funds from one to the other, depending on the state. Community property. Not community property. State. We've done it in both. But, but this is an actual transaction. So if, if they're transferring money and then somebody divorces the. A year later or five years later.

Gotcha.

I'm not sitting here telling you exactly what's going to happen. All I know is there's a risk that you may be given control and, or interest in property if, you know if you're going to be divorced some years in the future. And although most of the people we deal with out of multiple hundreds, I've only heard of one that came through the grapevine being divorced. So I'm sure there might have been others. I hadn't heard about them. But it's an actual transaction. This is not a simulation. It's not a fabrication. It's an actual transaction. And so people need to be aware of that risk.

Gotcha. Interesting. Yeah, yeah. I'm kind of chuckling because it's like, yeah, I guess if you give your spouse money and then they leave you.

Or you guys, it's death and divorce. Those are literally the only two risks. Yeah, well, financial advisor. But again, that's not my, you know, why you're doing it. That would assume that they will get to me before they get past that. So I don't worry about that.

Yeah, well, hopefully. Yeah. So before you call Marcus, you definitely want to make sure that, you know, you're, you got a good relationship, you guys got a good plan, you got a good advisor, and you go through that process and deal with it. Interesting. Yeah. So one of the things we were talking about before you hopped on was, you know, like, what's, what's kind of like the, if you can condense this down, you know, early access, early conversion, you know, people can take take control back of their money so that they can potentially. Because I know a lot of investors, Marcus, they've been successful in their careers, they've got several million dollars in their 401k and they're like, man, I'd really love to put this money to work in some alternatives they set up like self directed IRAs, but this is another step to that where they can potentially, you know, gain access or getting more tax effective.

Getting access. One of the, one of the, probably the most popular recently. It started out, as I said, the first two or three, but I would say the most recent example we've had in the last five years is kind of converting to Roth funds because you can get access to the funds without the 10% penalty. You can take some of those funds or roll it over to your spouse's IRA and let them do conversions to take advantage of paying the tax without the 10% penalty and converting and putting in Roth IRAs or self directed IRAs or other types of investments so that you kind of get rid of the tax so that the funds grow without that tax deferred.

Yeah, I love that. So that's really, you're kind of taking the philosophy that we talked about in the beginning of the, of the show here, which is, you know, if you want to gain access to your money and you want to gain more control over it in a qualified plan, not only does this potentially do that, but then you can take it a step further and put it in, say, a Roth ira. So you can, you know, safeguard it, hopefully to an extent, unless the tax law changes, but hopefully safeguard that from those future tax implications that you may have. Gotcha. And there is, you know, we've got, if, if you're listening and you're like, well, how do I do that? Reach out to us. Reach out to me. At Chris nextlevelincome.com we've got several groups that you can contact and that can help you, you know, with that tax strategy. You know, Marcus, the one thing is, I think, you know, this has definitely raised, you know, a lot of questions from, from our audience, from listeners. So we don't, we don't do this that often. But we're going to set up a webinar in conjunction with this podcast. So.

Great.

This podcast is going out. We're going to do another webinar. And we'll have the info along in the show notes here. So if you're listening here and you say, hey, this is really interesting, I'd like to learn more. Go ahead and click below for that webinar. And also we've set up a special link at your website, marcus in marriagequadro.com forward/nli for next level income. That's in marriage. Qdro.com forward slash NLI. And you can go there, learn more about Marcus and his group and how they can help you if this is something that you're interested in. Marcus, anything else you'd like to add before we wrap up?

I will add one more thing that'll kind of blow your mind just to. Because again, when I started doing this, I was not, I'm not an estate planning attorney. I'm not a financial advisor. So I was taught applications by people as you get experience. And a lot of it's, can we do this? And it's like, all right, well, let's, let's, let's investigate. Right. So the, the one that I always use, the most exciting one is this was Primarily written for 401ks, 457 plans, 403bs.

Yeah.

But somebody asked, can you do, can you get cash out of a pension? And so we. One where not every plan, but some plans allow lump sum quadros. So we did one, an executive at this national company, he was still five years away from his retirement, and so we were able to go and take over a million dollars out of his pension, not as 401k out of his pension, let his wife convert that to a lump sum IRA rollover, and then start doing the Roth conversions literally from his pension.

Wow. Wow. You know, so very interesting.

You wouldn't even have been thought about that, you know, you know, instead of it just being sitting there in his pension. So it, there's, there's just, there's a lot of stuff that even when I first started, I wouldn't have thought of, but you kind of just see it if it fits and if there's any other applications out there.

Yeah. That's wild. So, yeah, so if you're listening and you've got any of these scenarios that we've talked about, you know, including pensions. Now that's another, that's another interesting way, and I love what you just said. You know, you don't look at the tax code and say, oh, this isn't what we do. You can say, wait, can we, can we apply this to this situation in a way that's compliant and then see if it applies to your situation to optimize taxes.

Correct? That's exactly right.

Marcus, this has been great. I've been very fascinating to me. I don't know if we'll be using it, my wife and I, but if cause we kind of the ship sailed on a couple of these things, but certainly something I wish I knew about a little bit earlier. But thanks for taking the time and sharing what in Marriage Quadro is with our audience today.

I appreciate it. Thank you, Chris.

Hey Chris here again. I hope you found this episode valuable. Now I have one more thing to give to you. We have a page for my coaching clients where you can get a free copy of my book as well as much more from previous guests on the show. Just check out nextlevelincome.com coaching to get a free copy of my book, audiobook and much more. I'll send you a copy of my book and cover all the shipping costs as a thank you for listening to the podcast. Also, please like share and take just 90 seconds to give us a rating on Apple Podcasts.