The Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted Dec. 20 as part of a government spending package (PL 116-94), allows parents to take early withdrawals of up to $5,000 from their retirement accounts without penalty within a year of a child’s birth or adoption. Although retirement plans can permit these distributions starting Jan. 1, 2020, some employers may want to wait for much-needed guidance on a number of practical and technical questions. This article is the first in a series that will examine the SECURE Act’s impact on retirement plans.
Withdrawals from tax-favored retirement plans prior to age 59-1/2 are generally subject to a 10% early distribution tax (in addition to regular income tax) under Section 72(t) of the Internal Revenue Code, unless one of several exceptions applies. The SECURE Act adds a new exception for a “qualified birth or adoption distribution” (QBOAD).
A QBOAD can be taken from any “eligible retirement plan” (as defined in Code Section 402(c)(8)(B)) other than a defined benefit plan. This includes 401(k) and other qualified defined contribution plans, 403(b) plans, governmental 457(b) plans (early distributions from these plans aren’t subject to the penalty tax) and individual retirement accounts (IRAs). Employers sponsoring these plans can — but aren’t required to — offer QBOADs to employees.
Employees can take a QBOAD during the one-year period after the date of a child’s birth or adoption. For QBOADs, an “eligible adoptee” is anyone (other than a spouse’s child) younger than age 18 or incapable — physically or mentally — of self-support.
QBOADs are limited to $5,000 per individual for each birth or adoption. The limit applies to all plans in which the employee participates, including other plans within the employer’s controlled group, other employers’ plans in which the employee has an account balance and any IRA held by the employee. The $5,000 limit applies to an individual — not a family — so the employee’s spouse may separately receive up to $5,000 as a QBOAD, even if both spouses work in the same controlled group.
Although the limit seems straightforward, employers may have some practical questions:
An individual may repay a QBOAD to the distributing plan (if it accepts rollover contributions) or an IRA. The repayment is treated as a rollover contribution. However, two important limitations apply to repayments to an employer-sponsored plan. First, repayment is allowed only if the individual is still eligible to make contributions to the plan (other than QBOAD repayments). Second, the repayment amount can’t exceed the QBOAD.
Again, this raises a number of practical questions:
QBOADs aren’t subject to the 20% mandatory withholding that applies to eligible rollover distributions (and the special tax “402(f)” notice isn’t required). Instead, QBOADs are subject to the usual tax withholding rules for lump sum payments that aren’t eligible rollover distributions — i.e., mandatory 10% withholding, unless the employee elects no withholding.
QBOADs are not hardship distributions. They are an entirely new type of distribution subject to their own rules. But adding QBOADs to a plan might affect hardship withdrawals: To take a hardship withdrawal, an employee must take all currently available distributions from all plans maintained by the employer. This presumably will include QBOADs if an employer decides to offer them.
Plans can start offering QBOADs this year. Sponsors implementing QBOADs this year will need to revise their administrative procedures immediately, including providing explanations of the distributions to participants, verifying eligibility, ensuring proper withholding and allowing for repayment.
However, the many unanswered questions may leave employers reluctant to rush into offering these distributions. In particular, employers may want to wait to see what steps, if any, they must take to substantiate an employee’s eligibility. Hopefully, IRS will prioritize guidance on QBOADs, given employees’ interest in these distributions.
Employers that choose to offer QBOADs will need to amend their plans accordingly. Under the usual amendment timing rules, discretionary plan amendments are due by the end of the plan year in which they take effect. However, the SECURE Act states that amendments for its changes won’t be due before the last day of the first plan year beginning on or after Jan. 1, 2022 (or a later date prescribed by IRS).