Having a new baby is expensive. According to the USDA Report: Expenditures by Families on Children, a family will spend over $13,000 annually on a new child. New parents are often surprised when everything costs more than expected. Where will the money come from? A recent change in the law offers access to much-need funds from an unexpected source – your retirement account.
USE YOUR IRA OR 401(K) TO COVER NEW BABY EXPENSES
The federal SECURE Act (the “Act”) brought significant changes to how many Americans plan for retirement. One of the more popular changes is good news for anyone thinking of starting a new family or adding to an existing one. Following the birth or adoption of a child, parents are permitted to withdraw up to $5,000 from an IRA or 401(k) plan without incurring a 10% early withdrawal penalty.
Prior to the SECURE Act, individuals under 59 ½ that withdrew pre-tax funds from an IRA or 401(k) plan would incur a 10% early withdrawal penalty and have the entire distribution treated as taxable income in the year it was taken.
HOW DO I GET MY $5,000?
After the birth or adoption of a child (the “qualifying event”), a parent is permitted to take a distribution of up to $5,000 from an IRA or a 401(k) plan. Timing of the distribution is particularly important since the withdrawal must be taken after the birth or adoption of a child. Parents have up to one (1) year following the date of birth or date the adoption is finalized to take the distribution from their retirement account to avoid the 10% early withdrawal penalty.
DOES THE $5,000 LIMIT APPLY TO EACH PARENT?
Yes, the $5,000 distribution is available on a per parent, per child basis. For a married couple, each spouse can take a penalty-free distribution of up to $5,000 for a qualified birth or adoption.
EXAMPLE: Let’s assume a married couple, Mr. & Mrs. Watt, each with their own employer-sponsored 401(k) plans, had twins on January 1, 2021. Both parents may take up a $5,000 distribution for each child from their respective retirement account, for a combined distribution of $10,000 per parent, any time up until December 31, 2021.
WILL I OWE INCOME TAX ON AN EXEMPT EARLY WITHDRAWAL?
Yes, but it is avoidable. The 10% early withdrawal exemption is available for each qualified birth or adoption, making you eligible for a penalty-free distribution. Please note, while this exemption allows parents to avoid an early withdrawal penalty, the withdrawal is still treated as taxable income in the year the distribution occurs. You can avoid all tax on the withdrawn money if you return it to the same or different IRA or tax-deferred investment within sixty (60) days.
ARE THERE ANY DRAWBACKS TO TAKING AN EXEMPT EARLY WITHDRAWAL?
It depends on your circumstances. While the $5,000 could help manage expenses associated with the birth or adoption of a new child, you should consider other options before tapping into your retirement account. It is important to understand how taking a withdrawal will affect your overall financial situation, including any potential liabilities you may incur. Please consult your attorney or tax advisor to provide a more in-depth analysis.
IS THE EXEMPTION AVAILABLE TO EVERYONE?
While the SECURE Act authorizes up to $5,000 penalty-free distributions after the birth or adoption of a child, companies decide whether they provide this option to their employees. Please contact your employer to find out if your retirement plan has this option.
Having a Baby is a Great Time to Get Your Will Done
You’ve got a (bigger) family now – it's time to make sure they’re taken care of after your gone. Get your Will started today – we make it very easy.
For more information about the SECURE Act or questions about estate planning for your family, please call (412) 391-1014 to be connected with one of our experienced estate planning attorneys. We make it easy to protect your family and plan for retirement. We guide you and your family using our flat fee billing methods so there is never a surprise with one of our invoices. Our attorneys prepare thousands of wills, trusts, powers of attorney, and healthcare directives annually for people all across Pennsylvania just like you.