Childbirth And Adoption Penalty Exception Added

On December 20, 2019, President Trump signed into law the Appropriations Act of 2020, which included a number of tax law changes. The Act included retroactively extending certain tax provisions that expired after 2017 or were about to expire. One of the exceptions added was a childbirth and adoption penalty. This article is one of a series of articles dealing with those changes and how they may affect you.

When you need cash, what are your options

If you are looking for cash for a specific purpose, your retirement savings may be a tempting source. However, if you are under age 59 ½ and plan to withdraw money from a traditional IRA or qualified retirement account, taking money from this source is usually a poor choice. If you do choose to withdraw your money this way, 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pay both income tax and a 10% early-distribution tax (also referred to as a penalty) on any previously untaxed money withdrawn.

Withdrawals you make from a SIMPLE IRA before age 59 ½ and during the two-year rollover-restriction period after establishing the SIMPLE IRA may be subject to a 25% additional early-distribution tax. This is 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, consider these two serious consequences:

A decrease in your retirement savings. (This also includes any 401(k) plan, a 403(b) tax-sheltered annuity plan, or a self-employed retirement plan.)
Resulting increases in taxes and penalties you will owe.

Childbirth and Adoption Penalty Exception

Congress has added another exception to the early-withdrawal penalty 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 is $5,000, applied individually. This means 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 is born. Or when the legal adoption of an eligible adoptee by the individual is finalized. An eligible adoptee is 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. And therfore is subject to certain requirements. But remember that if the withdrawn funds are not recontributed to the plan, the distribution will be taxable.

Other Penalty Exceptions

The childbirth and adoption penalty 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:

1) 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.

2) 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.

However, don’t forget: even if you are not subject to the 10% penalty, you will still have to pay taxes on the distribution itself.

You should be aware that the information provided above is just an overview of some of the penalty exceptions. Other conditions may need to be met before you qualify for a particular exception. Call us at (360) 778-2901 before tapping your retirement funds for uses other than retirement.

Distributions are most often subject to both normal taxes and other penalties. Taxes and penalties can take a significant bite out of the distributions. However, both taxes and penalties can be minimized through carefully planned distributions. Please contact our office for assistance.

If you missed any of the earlier tax law change articles you can view those articles at the links below: