Penalty Free Withdrawal for Adoption with the new SECURE Act
After months of uncertainty, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, clearing the way for one of the most significant pieces of retirement plan and education account legislation in more than a decade. On December 20, President Trump signed the SECURE Act into law.
The SECURE Act makes numerous changes to both Internal Revenue Code (IRC) and Employee Retirement Income Security Act (ERISA) that will expand retirement plan coverage for workers and increase savings opportunities. A welcome addition to the bill and beneficial for adoptive families, a new exception to the 10% early distribution penalty:
Exception would allow a penalty free distribution up to $5,000 from an IRA or employer plan referred to as “Qualified Birth or Adoption Distribution.” To qualify, the account owner must take a distribution during the one-year period beginning on either (1) date of birth or (2) date on which the adoption (individual must be under age 18) is finalized. The provision allows the individual that took the distribution to repay the distribution back to the plan or IRA at a later date. (the new rule can be found in Sec.113, also copied below)
This means a penalty-free withdrawal of $5,000 from your 401(k) accounts to defray the costs of having or adopting a child. If the parents have separate retirement plans, they can each withdraw up to $5,000.
Generally, a distribution from a retirement plan must be included in income. And, unless an exception applies (for example, distributions in case of financial hardship), a distribution before the age of 59-1/2 is subject to a 10% early withdrawal penalty on the amount included in income.
Starting in 2020, plan distributions (up to $5,000) that are used to pay for expenses related to the birth or adoption of a child are penalty-free. That $5,000 amount applies on an individual basis, so for a married couple, each spouse may receive a penalty-free distribution up to $5,000 for a qualified birth or adoption.
Adopting a child is an expensive endeavor, one many families struggle to afford. The penalty free withdrawal opens a new source of money to tap in to to help with any expenses tied to adding a new child to the family. New parents have a year to take the withdrawal after the birth or adoption of a child and it needs to take place after the child’s arrival, which means it can’t be used for costs incurred leading up to a planned birth or adoption.
Adoption portion of the SECURE Act:
SEC. 113. PENALTY-FREE WITHDRAWALS FROM RETIREMENT PLANS FOR INDIVIDUALS IN CASE OF BIRTH OF CHILD OR ADOPTION.
(a) In General.—Section 72(t)(2) of the Internal Revenue Code of 1986 is amended by adding at the end the following new subparagraph:
“(H) DISTRIBUTIONS FROM RETIREMENT PLANS IN CASE OF BIRTH OF CHILD OR ADOPTION.—
“(i) IN GENERAL.—Any qualified birth or adoption distribution.
“(ii) LIMITATION.—The aggregate amount which may be treated as qualified birth or adoption distributions by any individual with respect to any birth or adoption shall not exceed $5,000.
“(iii) QUALIFIED BIRTH OR ADOPTION DISTRIBUTION.—For purposes of this subparagraph—
“(I) IN GENERAL.—The term ‘qualified birth or adoption distribution’ means any distribution from an applicable eligible retirement plan to an individual if made during the 1-year period beginning on the date on which a child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized.
“(II) ELIGIBLE ADOPTEE.—The term ‘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.
“(iv) TREATMENT OF PLAN DISTRIBUTIONS.—
“(I) IN GENERAL.—If a distribution to an individual would (without regard to clause (ii)) be a qualified birth or adoption distribution, a plan shall not be treated as failing to meet any requirement of this title merely because the plan treats the distribution as a qualified birth or adoption distribution, unless the aggregate amount of such distributions from all plans maintained by the employer (and any member of any controlled group which includes the employer) to such individual exceeds $5,000.
“(II) CONTROLLED GROUP.—For purposes of subclause (I), the term ‘controlled group’ means any group treated as a single employer under subsection (b), (c), (m), or (o) of section 414.
“(v) AMOUNT DISTRIBUTED MAY BE REPAID.—
“(I) IN GENERAL.—Any individual who receives a qualified birth or adoption distribution may make one or more contributions in an aggregate amount not to exceed the amount of such distribution to an applicable eligible retirement plan of which such individual is a beneficiary and to which a rollover contribution of such distribution could be made under section 402(c), 403(a)(4), 403(b)(8), 408(d)(3), or 457(e)(16), as the case may be.
“(II) LIMITATION ON CONTRIBUTIONS TO APPLICABLE ELIGIBLE RETIREMENT PLANS OTHER THAN IRAS.—The aggregate amount of contributions made by an individual under subclause (I) to any applicable eligible retirement plan which is not an individual retirement plan shall not exceed the aggregate amount of qualified birth or adoption distributions which are made from such plan to such individual. Subclause (I) shall not apply to contributions to any applicable eligible retirement plan which is not an individual retirement plan unless the individual is eligible to make contributions (other than those described in subclause (I)) to such applicable eligible retirement plan.
“(III) TREATMENT OF REPAYMENTS OF DISTRIBUTIONS FROM APPLICABLE ELIGIBLE RETIREMENT PLANS OTHER THAN IRAs.—If a contribution is made under subclause (I) with respect to a qualified birth or adoption distribution from an applicable eligible retirement plan other than an individual retirement plan, then the taxpayer shall, to the extent of the amount of the contribution, be treated as having received such distribution in an eligible rollover distribution (as defined in section 402(c)(4)) and as having transferred the amount to the applicable eligible retirement plan in a direct trustee to trustee transfer within 60 days of the distribution.
“(IV) TREATMENT OF REPAYMENTS FOR DISTRIBUTIONS FROM IRAS.—If a contribution is made under subclause (I) with respect to a qualified birth or adoption distribution from an individual retirement plan, then, to the extent of the amount of the contribution, such distribution shall be treated as a distribution described in section 408(d)(3) and as having been transferred to the applicable eligible retirement plan in a direct trustee to trustee transfer within 60 days of the distribution.
“(vi) DEFINITION AND SPECIAL RULES.—For purposes of this subparagraph—
“(I) APPLICABLE ELIGIBLE RETIREMENT PLAN.—The term ‘applicable eligible retirement plan’ means an eligible retirement plan (as defined in section 402(c)(8)(B)) other than a defined benefit plan.
“(II) EXEMPTION OF DISTRIBUTIONS FROM TRUSTEE TO TRUSTEE TRANSFER AND WITHHOLDING RULES.—For purposes of sections 401(a)(31), 402(f), and 3405, a qualified birth or adoption distribution shall not be treated as an eligible rollover distribution.
“(III) TAXPAYER MUST INCLUDE TIN.—A distribution shall not be treated as a qualified birth or adoption distribution with respect to any child or eligible adoptee unless the taxpayer includes the name, age, and TIN of such child or eligible adoptee on the taxpayer’s return of tax for the taxable year.
“(IV) DISTRIBUTIONS TREATED AS MEETING PLAN DISTRIBUTION REQUIREMENTS.—Any qualified birth or adoption distribution shall be treated as meeting the requirements of sections 401(k)(2)(B)(i), 403(b)(7)(A)(ii), 403(b)(11), and 457(d)(1)(A).”.
(b) Effective Date.—The amendments made by this section shall apply to distributions made after December 31, 2019.