Penalty-free Withdrawals From Certain Retirement Plans For Expenses Related To Child Birth or Adoption

February 7, 2020

Distributions from traditional IRAs and qualified retirement plans are generally included in income in the year received. With rare exception, distributions before age 59 ½ are subject to a 10-percent early withdrawal penalty on the amount includable in income. A common exception to the early withdrawal penalty is for distributions made in certain cases of emergency or financial hardship.
 
The SECURE Act provides an additional exception to the 10-percent early withdrawal penalty for a distribution of up to $5,000 from a defined contribution retirement plan or IRA made after December 31, 2019 which is used for expenses related to a qualified birth or adoption. To qualify for the penalty-free exception, the distribution must be made during the one-year period beginning on the date on which the child is born, or the adoption is finalized. Eligible adoptees are 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. Qualified birth or adoption distributions may generally be repaid to the retirement plan at any time.
 

• Amounts withdrawn for qualified birth or adoption expenses are included in the taxpayer’s income in the year withdrawn, but they are not subject to the 10 percent early withdrawal penalty or to mandatory 20 percent income tax withholding (because the new law says that they are not “eligible rollover distributions”). Qualified birth or adoption distributions generally can be repaid with after-tax dollars at any time, essentially allowing retirement plan participants to restore the full amount of the distribution to their plan accounts. So, if a participant withdrew $5,000 as a qualified birth or adoption expense, he or she could recontribute the full $5,000 back into the plan (even years later), even though the participant paid income tax on the distribution.
• The $5,000 limit is per individual. Thus, a married couple may each separately receive a $5,000 qualified birth or adoption distribution from an eligible retirement plan.
• The individual receiving the qualified birth or adoption distribution appears to be the only person who can repay it to the retirement plan or IRA. Thus, someone else could not directly repay the amount as a gift, but they could gift the funds to that individual, enabling him or her to repay the distribution.