Learning Center
Childbirth and Adoption Penalty Exception Added
Article Highlights:
- When a Distribution Is Subject to a Penalty
- Amount of the Penalty
- Birth and Adoption Penalty Exception
- Medical Expenses Penalty Exception
- Unemployed – Medical Insurance Exception
If you are looking for cash for a specific purpose, your retirement savings may be a tempting source. However, if you are under age 59½ and plan to withdraw money from a traditional IRA or qualified retirement account, then you will likely pay both income tax and a 10% early-distribution tax (also referred to as a penalty) on any previously untaxed money that you take out. Withdrawals you make from a SIMPLE IRA before age 59½ and during the two-year rollover-restriction period after establishing the SIMPLE IRA may be subject to a 25% additional early-distribution tax, instead of the normal 10%. The two-year period is measured from the first day when contributions are deposited. These penalties are just what you’d pay on your federal return; your state may also charge an early-withdrawal penalty in addition to the regular state income tax.
Thus, before making any withdrawals from an IRA or other retirement plan, including a 401(k) plan, a 403(b) tax-sheltered annuity plan, or a self-employed retirement plan, carefully consider the resulting decrease in retirement savings and increases in taxes and penalties.
Birth and Adoption Exception – The tax law provides for several exceptions to the early-withdrawal penalty, and Congress has added another one as part of the Appropriations Act of 2020 (SECURE Act). The new exception provides for penalty-free plan withdrawals for births or adoptions, for distributions taken from IRAs, qualified employer plans (such as 401(k)s) and government retirement plans after Dec. 31, 2019. However, the maximum aggregate amount of a qualified birth or adoption distribution by any individual with respect to any birth or adoption is $5,000, applied individually (so each spouse may separately receive $5,000 of qualified birth or adoption distributions).
A qualified birth or adoption distribution is one made during the one-year period beginning on the date when a child of the individual is born or when the legal adoption of an eligible adoptee by the individual is finalized. An eligible adoptee means any individual (other than a child of the taxpayer’s spouse) who has not attained age 18 or is physically or mentally incapable of self-support. In addition, such qualified birth or adoption distributions may be recontributed to an individual’s applicable eligible retirement plan, subject to certain requirements. But remember that if the withdrawn funds are not recontributed to the plan, the distribution will be taxable.
Other Exceptions – The birth/adoption exception is not the only penalty exception available that might be beneficial in the case of childbirth. The following two might also apply to help you avoid the penalty:
- Withdrawals from any retirement plan to pay medical expenses – Amounts withdrawn to pay unreimbursed medical expenses are exempt from penalty if they would be deductible as an itemized deduction on Schedule A for the year when the expense is paid and if they exceed 7.5% of your adjusted gross income. This is true even if you do not actually itemize your deductions.
- IRA withdrawals by unemployed individuals to pay medical insurance premiums – The amount that is exempt from penalty cannot be more than the amount you paid that year for medical insurance for yourself, your spouse, and your dependents. You also must have received unemployment compensation for at least 12 weeks during that year.
You should be aware that the information provided above is an overview of some of the penalty exceptions and that other conditions may need to be met before you qualify for a particular exception. You are encouraged to contact this office before tapping your retirement funds for uses other than retirement. Distributions are most often subject to both normal taxes and other penalties, which can take a significant bite out of the distributions. However, both the taxes and the penalties can be minimized through carefully planned distributions. Please call for assistance.
If you missed any of the earlier tax law change articles you can view those articles at the links below:
- Congress Allowing Higher Medical Deductions for 2019 and 2020
- Employer’s Pension Startup Credit Substantially Increased
- Above-the-Line Education Tax Deduction Reinstated
- Mortgage Insurance Premium Deduction Retroactively Extended
- The Home Energy Saving Tax Credit Is Back
- Did You Pay Tax on Home Mortgage Debt Relief in 2018
- New Twist for Kiddie Tax with a Refund Opportunity
NEVER MISS A STORY.
Sign up for our newsletters and get our articles delivered right to your inbox.
Rose Tax & Financial
Cedar Crest, New Mexico 87008
Sat: 10:00am to 2:00pm
Check the background of your financial professional on FINRA's BrokerCheck
Avantax affiliated Financial Professionals may only conduct business with residents of the states for which they are properly registered. Please note that not all of the investments and services mentioned are available in every state. Securities offered through Avantax Investment Services℠, Member FINRA, SIPC, Investment Advisory services offered through Avantax Advisory ServicesSM, Insurance services offered through an Avantax affiliated insurance agency. 3200 Olympus Blvd., Suite 100, Dallas, TX 75019. 972-870-6000.
The Avantax family of companies exclusively provide financial products and services through its financial representatives. Although Avantax Wealth Management® does not provide or supervise tax or accounting services, Avantax representatives may offer these services through their independent outside business. Content, links, and some material within this website may have been created by a third party for use by an Avantax affiliated representative. This content is for educational and informational purposes only and does not represent the views and opinions of Avantax Wealth Management® or its subsidiaries. Avantax Wealth Management® is not responsible for and does not control, adopt, or endorse any content contained on any third party website.
This information is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
The information being provided is strictly as a courtesy. When you link to any of the web sites provided here, you are leaving this web site. We make no representation as to the completeness or accuracy of information provided at these web sites. Nor is the company liable for any direct or indirect technical or system issues or any consequences.
For Important Information and Form CRS please visit https://www.avantax.com/disclosures.