Welcoming a new child into your family is an exciting time. However, if money is tight or your income has declined due to the pandemic, what should be a wonderful time in your life can quickly become stressful. If you need funds to support your new addition to the family, your 401 (k) might be able to help.
At the end of 2019, the SECURE law created the option to take up to $ 5,000 per parent and per child “Qualifying Birth or Adoption Distribution” (QBOAD) from a 401 (k) or another qualifying pension plan. Usually, when you take a distribution of your 401 (k) plan before the age of 59 1/2, you have to pay an early distribution penalty of 10%. The new regulations state that, as long as you take the distribution “during the year from the date of birth of the individual’s child or the finalization of legal adoption by the individual of an eligible adoptee The penalty is Keep in mind that you still have to report the amount of the distribution in your gross income for the year and pay regular income taxes.
When a distribution is not a distribution
Although a QBOAD is considered a distribution, you have the option of refunding it in the future. The rules allow you to “recontribute” all or part of the distribution that you have taken for a child. From now on, there is no time limit within which you must make your re-contribution. Keep in mind that the amount you can donate is do not adjusted for investment gains you may have missed when liquidating your investments. You can also do not include any taxes you had to pay in the amount you are allowed to remit. Finally, if you change jobs after taking a QBOAD, the regulations seem to state that you can make your re-contribution into a personal IRA.
Learn at work
Even though the government created the QBOAD, your employer must also allow this option in their 401 (k) plan before they can use it. If you would like to take a QBOAD, first contact the company that administers your 401 (k) plan. They should be able to tell you if your plan allows it. Even though this new option was created last year, many pension plan administrators are still updating their systems and planning documents to make a QBOAD possible. If this is already an option in your plan, follow the administrator process to document and request distribution.
If it’s not available in your plan, your next contact will be with your employer. Ask the human resources department – or your managers – if they are aware of this new distribution option. There is a reasonable chance that they are not. Send them this article or any other useful information. Explain in a logical way why adding a QBOAD will help you and potentially other employees. Most employers will respond favorably to this approach.
Then be patient. Your employer will have an internal process for determining whether to change their 401 (k) plan. Depending on the size of your employer, this could be a relatively quick decision. However, with large employers, this may require multiple people, committees, or even the involvement of lawyers. Plus, making changes to their retirement plan usually costs your employer money. Keep this in mind when making your request. If your employer decides to make the change, you should be able to request a QBOAD soon after the proverbial ink has dried on the necessary diet change.
If your employer doesn’t want to change their 401 (k) plan, regulations can still provide you with a way forward. In a recent IRS Questions and Answers it states that “If an applicable qualifying pension plan does not permit qualifying distributions from birth or adoption and a person receives an otherwise authorized in-service distribution that meets the requirements for an eligible distribution from birth or adoption, the person may treat the distribution as an eligible distribution. distribution of birth or adoption on the individual’s federal income tax return. If you qualify for this approach, the same rules for including the distribution in your gross income and the 10% early distribution fee waiver apply.
Distribute or not?
When money is tight or new spending is on the horizon; it can be tempting to dip into your retirement savings. While a QBOAD can be a quick way to get up to $ 5,000 per parent per child to help fund the immediate expenses of your growing family, it is not without consequences.
Money on hand today is valuable, but forgoing the future value of a $ 5,000 distribution could result in a significant reduction in your future retirement nest egg. Although you can redistribute the money you have distributed, you can only redistribute the actual amount of your distribution. For example, suppose that the investments in your 401 (k) plan that you liquidated to take a QBOAD of $ 5,000 would have been worth $ 7,500 when you are ready to make your re-contribution. If so, you can only return the $ 5,000 you withdraw from the plan. The lack of potential future investment income is an important consideration in taking a QBOAD.
Taxes cannot be neglected either. Although the 10% early withdrawal penalty is waived, you must still claim the distribution amount as part of your gross income. Depending on your federal, state, or even local tax bracket, this amount could be significant.
If you decide that a QBOAD doesn’t make sense and you’re still looking for help with your 401 (k) plan, you can apply for a loan if your plan allows. You can generally borrow up to 50% of your acquired account balance up to a maximum of $ 50,000. There is no credit check or qualification process. Interest rates are generally reasonable and set at the plan level. This means that the rates do not vary based on individual income level, credit scores, etc. Although you have to make loan payments and repay your loan within five years, the principal and interest are paid back to your own 401 (k) account. .
When you combine a new addition to your family with financial stress, it’s easy to make mistakes. Before deciding to take a QBOAD, be sure to evaluate all of your available options. It is essential to balance your short-term needs with the long-term financial implications. Sometimes the solutions available to deal with today’s expenses can have a disproportionate impact on your future finances.