Think hard before tapping into your Employer Sponsored Retirement Account balance
One of the features that make retirement plans so attractive is that your money may not be completely out of reach should an emergency need arise. Many employer plans allow for loans that are completely tax free if repaid as agreed. (Interest payments will be required, but they will be credited to the account.) In a major emergency, a hardship withdrawal may be permitted, subject to income tax and, usually, a 10% penalty as well.
Accessing your Retirement Account funds should be carefully considered.
At first glance, retirement account loans may look particularly appealing. After all, you make those payments of principal and interest to yourself. However, if the interest that you pay is less than your borrowed dollars would have earned in the plan, you will slow the growth of your retirement nest egg. Moreover, you pay with after-tax dollars—replacing your original tax-deferred contributions.
Loans must be repaid in no more than five years (15-year terms are allowed for loans to purchase a home). If you leave your job before a loan is repaid, you’ll have to pay it off, or the open balance will be considered a premature withdrawal subject to income tax and penalty.
Potentially more serious yet, the burden of loan payments may make it impossible to continue your Retirement Account contributions which also means the serious loss of potential earnings. Keep in mind that not all plans offer plan loans. If a loan is not an option, some plans may offer a “Hardship withdrawal” option.
It’s not easy to make a hardship withdrawal from your retirement account and not all plans offer a hardship withdrawal option but if your plan does offer a hardship withdrawal, you must show an “immediate and heavy financial need,” (As defined by the IRS) for:
Medical care that would be deductible under IRC 213(d) for the employee, the employee’s spouse, the employee’s dependents, or the employee’s primary beneficiary under the plan; Costs directly related to the purchase of a principal residence for the employee; Payments for tuition, related educational fees, and room and board expenses, for the next 12 months of post-secondary education for the employee, the employee’s spouse, the employee’s children, the employee’s dependents, or the employee’s primary beneficiary under the plan; Payments necessary to prevent eviction from the employee’s principal residence, or to prevent foreclosure on the mortgage on that residence; Payments for burial or funeral expenses for the employee’s deceased parent, spouse, children, dependents, or the employee’s primary beneficiary under the plan, or expenses for the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under IRC 165 (determined without regard to whether the loss exceeds 10% of adjusted gross income).
You also must show that you have no other resources reasonably available to meet these costs. This means that you first must fail to qualify for a plan loan if your plan offers a plan loan option. Once you take a hardship withdrawal, you will be barred from contributing to your plan for at least 6 months after the receipt of the hardship distribution.
The lesson: even though life happens and your employer sponsored retirement account may offer a means to access funds in the case of an emergency, tapping into your retirement plan assets should be your very last resort.
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