If you find yourself in need of funds to support a new addition to your family, your 401(k) plan ... [+]
Welcoming a new child to 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 turn stressful. If you find yourself in need of funds to support your new addition to the family, your 401(k) might be able to help.
At the end of 2019, the SECURE Act created the option to take up to a $5,000 per parent per child "Qualified Birth Or Adoption Distribution" (QBOAD) from a 401(k) or other eligible retirement plan. Usually, when you take a distribution from your 401(k) plan prior to age 59 1/2, you must pay a 10% early distribution penalty. The new regulations state, so long as you take the distribution "during the one year beginning on the date on which the child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized,” the penalty is waived. Keep in mind, you still must report the amount of the distribution in your gross income for the year and pay ordinary income taxes on it.
When a Distribution is Not a Distribution
Despite the fact a QBOAD is considered a distribution, you do have the option to repay it in the future. The regulation allows you to “recontribute” all or part of the distribution you took for a child. As of now, there is no time frame in which you have to make your recontribution. Keep in mind, the amount you may recontribute is not adjusted for any investment gains you may have missed out on from liquidating your investments. You also may not include any taxes you had to pay in the amount you are allowed to recontribute. Finally, if you change jobs after you take a QBOAD, the regulations seem to indicate you may make your recontribution into a personal IRA.
Ask About It At Work
Even though the government has created the QBOAD, your employer must also allow this option in their 401(k) plan before you may utilize it. If you want to take a QBOAD, first get in touch with the company that administers your 401(k) plan. They should be able to tell you whether your plan allows for them. Even though this new option was created last year, many retirement plan administrators are still updating their systems and plan documents to make a QBOAD possible. If it is already an option in your plan, follow the administrator’s process to document and request the distribution.
If it is not available in your plan, your next reach out is to your employer. Ask the human resources department—or your managers—if they are aware of this new distribution option. There is a reasonable chance they may not be. Forward this article or any other helpful information to them. Make a logical case as to why adding a QBOAD will help you and potentially other employees. Most employers will respond favorably to that approach.
Next, be patient. Your employer will have an internal process to determine whether to change their 401(k) plan. Depending on your employer's size, this could be a relatively quick decision. However, with larger employers it might require multiple people, committees, or even the involvement of lawyers. Also, making changes to their retirement plan generally costs your employer money. Keep that in mind as you make your request. If your employer decides to make the change, you should be able to request a QBOAD shortly after the proverbial ink is dry on the necessary plan amendment.
If your employer does not want to change their 401(k) plan, the regulations still may provide you with a path forward. In a recent Q&A released by the IRS it states that “If an applicable eligible retirement plan does not permit qualified birth or adoption distributions and an individual receives an otherwise permissible in-service distribution that meets the requirements of a qualified birth or adoption distribution, the individual may treat the distribution as a qualified birth or adoption distribution on the individual's federal income tax return.” If you qualify for this approach, the same rules around including the distribution in your gross income and the 10% early distribution fee waiver apply.
To Distribute or Not?
When money is tight or new expenses are on the horizon; it can be tempting to tap into your retirement savings. While a QBOAD could 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 in hand today has value, but forgoing the future value of a $5,000 distribution could result in a significant reduction of your future retirement nest egg. While you may recontribute the money you distributed, you may only recontribute the actual amount of your distribution. For example, suppose the investments in your 401(k) plan you liquidated to take a $5,000 QBOAD would have been worth $7,500 when you are ready to make your recontribution. If that is the case, you may only recontribute the $5,000 you took out of the plan. Missing out on potential future investment earnings is a significant consideration in taking a QBOAD.
Taxes also cannot be overlooked. While the 10% early withdrawal penalty is waived, you still must claim the distribution amount as part of your gross income. Depending on your federal, state or even local income tax bracket, that amount could be significant.
If you decide a QBOAD does not make sense, and you are still looking to the money in your 401(k) plan for help, you could apply for a loan if your plan allows them. You may generally borrow up to 50% of your vested account balance to a maximum of $50,000. There is no credit check or qualification process. The interest rates are generally reasonable and set at the plan level. Meaning, rates don’t vary by individual income levels, credit scores, etc. While you will need to make loan payments and to repay your loan within five years, both the principal and interest are paid back into your own 401(k) account.
When you combine a new addition to your family with financial stress, it is easy to make mistakes. Before you decide to take a QBOAD, be sure to evaluate all your available options. It is vital to balance your short-term needs with the long-term financial implications. Sometimes, available solutions to meet today's expenses can have an outsized impact on your future finances.
