The Secure Act 2.0 was passed in December 2022 and made a lot of changes to what you can do with your retirement money. The first Secure Act in 2020 allowed for a $5000 penalty-free hardship distribution for the birth or adoption of a new child. Section 311 of Secure 2.0 allows you to take the distribution and allows you to pay it back over 3 years.
You Can Pay It Back
Why this is important: It encourages you to keep your retirement money for retirement and not use it for emergencies and life changes. It allows you to ‘borrow’ it and pay it back to yourself without any penalty. But, with all things tax, you need to read the fine print.
Technically a Rollover
The IRS code section 72(t)(2)(H)(v)(I) (No, I’m not making that up.) says that hardship withdrawals for a new child are treated like a rollover. A ‘rollover’ is where you can take money out of retirement and put it back within 60 days. This allows you to move your money around and then invest however and wherever you please.
A hardship distribution for a new child should be treated as a rollover, but with three years to pay it back instead of only 60 days. Note that I said ‘should be.’ Employers may or may not be familiar with the new law and may not issue your 1099R tax statement correctly. It should be marked as a rollover (Code G in Box 7), no taxes withheld and no taxes due when you file in the Spring. If it is marked otherwise, see a tax professional or consult with the sender.
Distributions are Income
If you take a distribution, it is income. The money in your retirement was never taxed, so when you take it out, you have to pay income tax. Secure 2.0 allows you to pay your distribution back over 3 years. No penalties are incurred, and you don’t have to pay the tax until you retire.
What happens if you don’t pay it back? You are taxed on what was not paid back at the end of the three years. It will add the $5000 income to the final year.
Tax will be due April of the 4th year after you take it out. That means, if you take money out in 2024, you will need to pay it back or pay the taxes by April 2027. If you don’t remember, the IRS will certainly ask you about it a few years later. Keep good records. You need to be able to prove that it was paid back. Or you need to show that you paid the tax if you are not paying it back. Confused? Download my Audit Proof Worksheet and build a permanent record of all related transactions that will stand up to any audit.
Additional income can affect your overall tax situation. Eligibility for Earned Income Credit, Education Credits, how much of your Social Security is taxable, the price of your Marketplace health insurance, and more can all change if you have more income. You need to consider all the tax implications of having additional income if you decide to pay the taxes.
How to ‘Pay Back’ Retirement Money
If you took money from an IRA, you simply put it back anytime within the next three years.
If you took money from an employer 401k plan, you cannot directly pay it back to your employer. It is not an employer loan. You can, however, open a traditional IRA and then make ‘rollover’ contributions up to the original $5000 over the next 3 years. This is ‘paying it back’ into your retirement so you are not paying taxes on the money or reporting it as additional income. You need to inform the bank that you are making a self-rollover contribution.
Final Note
The qualifying withdrawal cannot be made until after the baby is born or the adoption is finalized. You cannot take the money out ahead of time.
Don’t forget to download my Audit Proof Worksheet to track and document your withdrawal, payback, and taxes paid on your withdrawal for a new child.
