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How New Parents Can Tap Their Retirement Savings Penalty Free

April 9, 2020 | Leave a Comment

Becoming a parent or adding a baby, while an exciting time, can also be stressful.  Of course, there are the sleepless nights and the round the clock baby care, but there are also financial considerations.  Many people are surprised how many expenses come with the birth of a baby.  And, you must also consider who will care for the child.  In the United States, maternity and paternity leave are not universal.  If you or your partner want to stay home for a few weeks after the baby is born (or adopted) and you don’t have maternity/paternity leave, you’ll either need to save money for it or find a way to cover your expenses while you stay home.  If you fall into the latter category, it’s important to learn how new parents can tap their retirement savings penalty free.

How New Parents Can Tap Their Retirement Savings Penalty Free

Thank the SECURE Act

The SECURE Act (short for The Setting Every Community Up for Retirement Enhancement Act), which passed in December 2019, now allows parents who’ve had a baby or adopted a child within the past year to take up to $5,000 out of their retirement account penalty free.  If each parent has their own retirement account, each individual can take out $5,000, meaning the couple can take out $10,000 total.

Normally, if a person takes money out of their retirement account before 59.5 years of age, they have to pay a 10% penalty.  The SECURE Act eliminates this penalty for new parents.

How New Parents Can Tap Their Retirement Savings Penalty Free

Photo by Jonathan Borba on Unsplash

Taxes Still Need to Be Paid

While you won’t have to pay the penalty, you will still have to pay taxes on the withdrawal.  Whether you withdraw $5,000 or $10,000 (if both partners withdraw $5,000), that money will appear as income on your tax form, and you will have to pay taxes on it.

Why You Should Carefully Consider Using this Option

While knowing how new parents can tap their retirement savings penalty free when you’ve had a baby is a nice option, you should try to avoid tapping your retirement for a number of reasons.

You Lose Compounding Interest

If you take $5,000 out of your retirement income, you lose the compounding interest that money was making for you.  Every month, that money was generating income, and now, it won’t be.

May Start a Dangerous Precedence

Retirement funds are for retirement.  Once you start pulling from your retirement, you may start doing that regularly.  It’s very easy to start thinking of your retirement account as a de facto emergency fund and pull money from it whenever you have an unexpected expense.  If you get into this pattern, you can easily decimate your retirement account.

I have a friend whose child had emotional issues, so my friend was desperate to help her child.  She sent him to residential treatment facilities and wilderness camps to try to help her son get his behavior under control.  Her insurance wouldn’t pay for these treatments, so she relied heavily on pulling money from her retirement account.  Now, her son is grown and still having emotional problems.  She, meanwhile, has emptied her retirement account and is starting over, trying to build a new retirement fund at the age of 45.  It’s not a good place to be.

Payback Options

Of course, you can take out the money, pay your taxes, and be done with it.  However, if you want to make up for what you had to take out, there are ways to do so.

Pay It Back Within Two Months

Check with your financial advisor, but for many retirement accounts, if you withdraw money from your retirement account and can return that money back to the account within two months, it’s as if you never withdrew the money.  You won’t have to pay taxes on it.  Think of it as a short-term, two-month loan.

This can be an excellent way to get a short-term loan, IF you can pay it back quickly.  This may help you if you want to take a one-month, unpaid paternity leave and know you can get the money back into your retirement fund the next month.

Pay It Back Overtime

Another option is to gradually pay it back over time.  Under this option, you still have to pay taxes on your distribution.  However, by paying back the money to your retirement account, you gain back the power of compounding interest on the money you originally withdrew.  With this strategy, your retirement account will be healthier and more robust than if you simply withdrew the money and never paid it back.

Other Times You Can Withdraw from Your Retirement Account Penalty Free

Beyond how new parents can tap their retirement savings penalty-free within a year of having a new baby or adopting a child, there are other times people can tap their retirement accounts penalty free.  However, before considering taking money out for any other reason besides having or adopting a child, consult your financial advisor.  Some rules differ depending on the type of retirement account you have (IRA or 401K).

Educational Expenses

You can tap your retirement account penalty free for related higher education expenses such as tuition, fees, supplies and books.  This money can be used for your own higher education, or for your spouse or children.

How New Parents Can Tap Their Retirement Savings Penalty Free

Photo by MD Duran on Unsplash

First-Time Home Purchase

If you’re a first-time home buyer, you can take $10,000 out penalty free to use as the down payment on your new home.  If your spouse has his or her own retirement account, he or she can also withdraw $10,000, giving you up to $20,000 toward your new home.

Medical Expenses

Some years you may incur significant medical expenses in a year (i.e. greater than 10% of your annual income).  During those years, you can take money out of your IRA to pay for medical bills without incurring a penalty.

Final Thoughts

The SECURE Act gives new parents flexibility when it comes to their retirement withdrawals.  However, keep in mind, whether you withdraw money for a new child or for any of the other reasons you can withdraw money penalty-free, you still will have to pay taxes.  You’ll also be losing the power of compounding interest on that money, which may be the biggest hit of all.

Melissa Batai
Melissa Batai

Melissa is a writer and virtual assistant. She earned her Master’s from Southern Illinois University, and her Bachelor’s in English from the University of Michigan. When she’s not working, you can find her homeschooling her kids, reading a good book, or cooking. She resides in Arizona where she dislikes the summer heat but loves the natural beauty of the area.

Filed Under: Money and Finances Tagged With: 401k, financially afford children, having children, IRA, Retirement

Why Should I Contribute Extra to My 401(k)?

February 4, 2014 | Leave a Comment

max your 401kMany people contribute to their 401(k) to get the matching contributions from their employer, if that is offered to them. However, a lot of people do not contribute more than the amount that their employer will match. Unfortunately, by not contributing extra to your 401(k) account, you’re missing out on plenty of benefits. Here are some of the top reasons why you should definitely contribute extra to your 401(k). You can check out the Suncorp superannuation calculator to find out how much you really need to retire.

 

1. You Get Automatic Savings

Contributions to your 401(k) plan are taken out of each of your paychecks every pay period, allowing for simple, automatic savings. You don’t ever have to make a bank transfer or write a check to deposit funds into your 401(k) account, making this an excellent option to save money, especially for those who don’t feel like they have the discipline to add to their savings regularly.

 

2. Tax Breaks are Available

When you contribute to your 401(k) plan, you are reducing your taxable income, as the government allows you to put a certain dollar amount each year into your plan before taxes are calculated on your gross income. While your funds are in your plan, taxes on all of the interest you make on both the money you contributed and any matching contributions your employer made are also deferred.

So, you don’t have to pay taxes on them until you take the money out of your 401(k) plan when you are ready to retire.  In addition, your contributions into your 401(k) plan can also help to drop you into a lower tax bracket where you would pay a lower rate on your taxes.

 

3. Your Contributions are Portable

All of the funds you contribute to your 401(k) plan are portable, allowing you to take those funds with you even if you switch jobs. It is important to keep in mind that you only have a 60-day deadline to do so, though, before you have to pay taxes on those funds, as well as a 10% penalty if you are less than 59 ½ years of age.

 

4. You Can Contribute More Than an IRA

The government allows for higher annual contributions to 401(k) plans than IRAs, which have a much lower limit on the amount of tax-deferred money you can contribute each year. In fact, you can contribute more than triple the amount each year to your 401(k) plan than you can to your IRA.

 

5. Social Security Will Not Provide Enough

Social security is only supposed to provide a percentage of your retirement income, not the full amount. So, a 401(k) could definitely help to make up another part of your retirement income, so you can live comfortably in your retirement. Contributing money into your 401(k) plan each month could definitely help you save up plenty of funds for your retirement, allowing you to retire when you want to and without worry of financial stress.

Do you try to max out your 401k contribution?

Brian
Brian

Brian is the founder of Kids Ain’t Cheap and is now sharing his journey through parenthood.

 
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Filed Under: Money and Finances Tagged With: 401k, 401k contributions, max your 401k

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Basic Principles Of Good Parenting

Here some basic principles for good parenting:

  1. What You Do Matters: Your kids are watching you. So, be purposeful about what you want to accomplish.
  2. You Can’t be Too Loving: Don’t replace love with material possessions, lowered expectations or leniency.
  3. Be Involved Your Kids Life: Arrange your priorities to focus on what your kid’s needs. Be there mentally and physically.
  4. Adapt Your Parenting: Children grow quickly, so keep pace with your child’s development.
  5. Establish and Set Rules: The rules you set for children will establish the rules they set for themselves later.  Avoid harsh discipline and be consistent.
  6. Explain Your Decisions: What is obvious to you may not be evident to your child. They don’t have the experience you do.
  7. Be Respectful To Your Child: How you treat your child is how they will treat others.  Be polite, respectful and make an effort to pay attention.
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