Baby Gift: SECURE Act Lets Parents Take Early Distribution without Penalty | Lord Abbett
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Retirement Perspectives

A new provision allows parents to take a distribution from their retirement plan after a birth or adoption without getting hit with the 10% penalty tax.

My last column discussed a significant provision in the SECURE Act: Increasing the RMD age to age 72 from 70½. In our third article on the new legislation, we’ll cover a new provision that has garnered a lot of attention: Account owners can take a distribution from their retirement account before age 59½ without getting hit with the 10% penalty tax to cover expenses for the birth or adoption of a child.

The new provision, “Qualified Birth or Adoption Distribution,” allows up to $5,000 across all eligible retirement plans to be distributed penalty-free from an individual retirement account (IRA) or a 401(k) plan within one year from the date of birth, or the date on which the adoption of an individual under age 18 is finalized. The adoption of a child of any age who is physically or mentally incapable of self-support is also eligible in the new provision.

Important to note: While the SECURE Act adds a new exception to the 10% penalty tax for birth or adoption, the distribution is still subject to income tax. The new provision is effective for distributions that take place after December 31, 2019.

 

Tip: The new Qualified Birth or Adoption Distribution does not include defined benefit plans.

 

Notably, the rules stipulate the distribution must occur after a qualifying event (birth or adoption), so the account owner can’t take a distribution to pay for adoption expenses prior to the date the adoption is finalized. However, an eligible individual could take a distribution to pay down the expenses previously paid. Moreover, there isn’t a requirement that the distribution cover qualifying expenses. The distribution simply must occur after a qualifying event. In other words, the proceeds can be used for any expense!

Plus, the new provision indicates that it applies on an individual basis. Therefore, if both parents have available assets, each parent can separately make a Qualified Birth or Adoption Distribution of up to $5,000 for each child born or adoption for a total of $10,000. All indications are the $5,000 limit is a separate limit “with respect to any birth or adoption” and seems to “start fresh” with each new qualifying event (i.e. birth or adoption).

The rules also allow for a Qualified Birth or Adoption Distribution to be repaid at a later date (notwithstanding the plan/IRA contribution limit) from either the plan the distribution was made or an IRA. However, the law is silent on a repayment deadline. Therefore, we need to wait for the IRS to issue regulations explaining repayment timing.

One more thing: The new Qualified Birth or Adoption Distribution is not a required (mandatory) qualified plan provision. Therefore, an individual will need to check see if this provision is offered in their qualified retirement plan. In reality, it’s highly unlikely this provision will be offered just yet. Why? Plan sponsors/IRA custodians will need to determine whether they want to offer a new distributable event. Assuming they do, they will need time to update forms, create processes, distribute notices and determine required documentation (qualifying the distribution), and communicate the new option to plan participants.

We’ll have more to say about the SECURE Act, including an explanation of what other key provisions mean for retirement investors. Stay tuned.

Advisors, if you have additional questions, please contact your Lord Abbett representative at 888-522-2388.

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

GLOSSARY

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.

A 403(b) plan (also called a tax-sheltered annuity or TSA plan) is a retirement plan offered by public schools and certain 501(c)(3) tax-exempt organizations. Employees save for retirement by contributing to individual accounts. Employers can also contribute to employees' accounts.

A 457 plan is available for certain state and local governments and non-governmental entities tax exempt under IRC Section 501. They can be either eligible plans under IRC 457(b) or ineligible plans under IRC 457(f). Plans eligible under 457(b) allow employees of sponsoring organizations to defer income taxation on retirement savings into future years. Ineligible plans may trigger different tax treatment under IRC 457(f).

A defined contribution plan is a retirement plan that's typically tax-deferred, e.g. a 401(k), at employers. An employee contributes a percentage of his/her paycheck in an account to fund retirement. The sponsor company will generally match a portion of employee contributions.

A required minimum distribution (RMD) is the minimum amount an account owner must withdraw from a retirement account each year. An owner generally has to start taking withdrawals from a retirement plan account at age 70½. Roth IRAs do not require withdrawals until after the death of the owner.

WEBINAR

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Have questions about the SECURE Act? Register for our webinar with Brian Dobbis and Steve Dopp on Tuesday, Feb. 18 at 1 pm ET. Advisors attending the live session can earn 1 CFP and/or IMCA CE credit.

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