It is the beginning of the year and many people have already started preparing their taxes for April. If you took money out of your 401(k) or other retirement savings, you likely have some penalties to pay on the amount you withdrew. However, new parents can take a penalty-free early withdrawal from retirement savings, but it will increase your taxable income.
Why New Parents Get This Break
Being a new parent can be extremely overwhelming and expensive. New parents get a small break if they need to withdraw funds from their retirement savings with the Secure Act, which was passed in December. If you are struggling for money, this can be a good source of emergency cash.
It is important to note that the penalty-free early withdrawal only applies to individuals with new children. There is also an exception for medical expenses, but you need to make sure that the year you withdraw the funds is also the year you needed medical assistance. You won’t be able to withdraw funds from your retirement savings in the event of financial hardship or any other reason without paying the 10 percent withdrawal fees.
While having that extra cash to fall back on is great, there are definitely a few things to be wary of. Even if you need the money for your child or a medical expense, it may not be the best financial decision.
Should You Consider a Penalty-Free Early Withdrawal?
The Secure Act will allow parents with a new child to deduct up to $5,000 from their retirement savings or individual retirement account (IRA) without having to pay the 10% penalty. The $5,000 limit applies to each parent, meaning the family can deduct up to $10,000 in total as long as they have separate retirement accounts.
Even though they won’t have to pay the 10% penalty, parents will still have to pay taxes on this money. Not to mention, you’ll be removing money from retirement savings that likely took years to accumulate and could take years to re-establish. Additionally, you are creating a habit of borrowing, which is never beneficial to your long-term finances.
Ed Slott, CPA and founder of Ed Slott and Co. said, “Retirement funds are for retirement. If you use them well before retirement, what are you going to have in retirement?” All in all, it is probably not the best idea to withdraw from your retirement savings early. Instead, look for other ways to fund your needs and focus on saving more so you don’t have to resort to deducting money from your 401(k) or IRA.