Tax Insights

Your Guide to State, Local, Federal, Estate + International Taxation

Penalty Free Retirement Account Withdrawals

tax credit, family, medical, leaveFor anyone who has a child, they know sometimes the pain doesn’t end at the point of delivery.  Don’t get me wrong. Children are a blessing, but with them come sleepless nights, diaper changes and yes, financial pressures. A study by Health Affairs found that for the average new mother with insurance who gave birth between 2008 and 2015 the out of pocket cost of labor and delivery averaged $ 4,500.  For those individuals adopting a child, a report from Adoptive Families Magazine indicated the average cost of adoption through a private agency is $43,000.

Kiddie tax laws have changed

Distributions from eligible retirement plans prior to the age of 59.5 are generally subject to a 10% penalty. The recently enacted SECURE Act now allows individuals a penalty free distribution from their eligible retirement plan of up to $5,000 for a single qualified birth or adoption. The $5,000 applies on an individual basis so a married couple could each withdraw $5,000 for a total of $10,000 in penalty free withdrawals for a single qualified birth or adoption. The distribution can be made from an eligible retirement plan if it is made during the 1-year period that begins on the date of the child’s birth or on the date which the legal adoption of the individual is finalized.

The distribution can be made from qualified retirement plans, section 403(B) plans, governmental section 457(b) plans and Individual Retirement Accounts. While the distribution will not be subject to the 10% penalty it is important to note that it is considered taxable income and subject to withholding unless the recipient elects otherwise.

The SECURE Act did provide for the ability to repay the distributions to the retirement plan and claim rollover treatment. The act does not provide a deadline as to when the recontribution must be made to be afforded rollover treatment and thus not subject to tax. It would appear the rollover needs to be made before the statute of limitations for filing a claim for refund for the year of the original distribution. You generally have three years from the date of filing your return to claim a refund. There is a special rule if the amount distributed was from a plan other than an IRA. The amount contributed as repayments to an employer plan is limited to the amounts distributed from that particular plan, and the repayment rule will only apply if the employee is eligible to make such repayment to the plan.

The name, age and taxpayer identification number of the child whose birth or adoption qualifies will need to be provided to claim the exception to the 10% penalty when filing your return. The provisions related to the penalty-free withdrawal are in affect for distributions made after December 31, 2019.

Any time you experience a major life transition – marriage, divorce, a new baby, etc. – be sure to contact your Henry+Horne tax advisor who can assist with any necessary tax planning.

Cheryl Dickerson, CPA