Updated: Jul 31, 2020
The SECURE Act, passed in January 2020, was designed to make it easier to save for retirement by making retirement plans more accessible to more people and updating the laws that govern retirement plans to meet the needs of a changing workforce. Although many of the provisions are aimed at older workers and those closest to retirement, there are a few benefits designed for young workers, especially those who may be looking to start a family.
One such provision creates the option for an in-service withdrawal for "qualified birth or adoption distributions." This distribution can be made to an employee within one year from the date on which a child is born or on which a child is legally adopted. The adopted child must be under 18 years of age or must be physically or mentally incapable of supporting themselves. This provision allows parents who just had a baby or adopted a child to take a withdrawal of up to $5,000 from their defined contribution plan or IRA. If the parents have separate retirement accounts, they can both withdrawal $5,000 to bring their combined total to $10,000. Although the typical 10% penalty is waived, taxes are still taken from that withdrawal - usually within 12 months. While repayment of this amount is not required, parents can opt to repay the amount. If the employee wishes to repay the distribution, they can do so by making contributions to a plan in which they participate, up to the amount of the distribution. If employers want to offer this qualified birth or adoption distribution, they will need to amend their plans to add this new distribution as well as amend the plan's rollover provisions if they wish to allow repayments to be made.
Whether birthing a child or adopting, national averages show that the cost hovers around $40,000. Even with the best insurance, most parents will incur out-of-pocket expenses. While most parents would agree that there is no sacrifice for your child too great to bear, parents should consider the big picture of their finances before jumping at the opportunity to take this withdrawal as a stop-gap measure for the expense of a child.
Although there is no penalty for this distribution, the money will still be taxed. Depending on the parent’s annual income, the addition of these funds could push them into a higher tax bracket, resulting in a sharp increase in their annual taxes. A larger tax bill at a time of financial instability could be an overwhelming burden. Yet another consideration should be for financial well-being in the future, as this withdrawal could have a serious impact on retirement savings. It is important to remember that an individual is not simply losing the $5,000 they withdrawal, but also the return on those investments. If there is a 7% annual return on a $5,000 investment over 25 years, one would accumulate $28,633. Although there are occasions where it is necessary to take extreme measures to stabilize finances, one must be mindful of the impact that every dollar makes in retirement savings.
If you do not have the money allocated to cover the costs of the birth or adoption of a child, you might need to take advantage of this provision, but it is important to consider all of the possible ramifications of taking this withdrawal. If you have additional questions about this provision or any others in the SECURE Act, we want to help. Let us know how we can serve as a resource for you.