Retirement plans exist to help you ensure a comfortable retirement. Pre- or after-tax money is put away every month and invested in different instruments so when you reach your desired retirement age, you can afford the lifestyle you hope for. Until then, the most obvious rule of thumb, reinforced by every financial professional you meet in your life is – Do Not Touch That Money! Loans from retirement plans are a possibility but are discouraged and withdrawals ever more so. The reality is, however, that sometimes unexpected and sudden illness strikes accompanied by astronomic medical expenses and at that point many turn to their retirement plans.
So if you are in a situation of little or no liquid assets and an immediate need for cash to cover medical expenses, this article will explain how to withdraw from your retirement plans during this difficult time in your life. I would like to stress on the point that using cash from retirement plans to cover illness expenses should be a last resort option.
Know Your Retirement Accounts
It’s imperative to know the rules of your retirement accounts as it pertains on how money can be used in the case of illness without a penalty. In most cases, plans allow for hardship distributions. To be certain that hardship distributions are allowed in your specific plans, either read the fine print of ask a human resources specialist. Usually, for 401K and 403B plans the IRS requires that you access all other available distributions and loans from the plan first. Just another reminder that hardship distributions should really be just that – last resort in dire situations!
457B plans on the other hand have stricter definitions of hardship. Distributions are only allowed when a participant has an unforeseen emergency. For example, a sudden diagnosis of a serious illness would fit that category. Documentation is required and your employer must prove that you don’t have any other resources to meet your need.
If you are older than 59 1/2 you can access your IRA account without a penalty. If you are younger, you can use cash from your IRA account to cover medical expenses if:
– You have unreimbursed medical expense above 10% of your adjusted gross income.
– You have “total and permanent” disability as determined by a physician, and you cannot work for at least a year, or the condition will result in your death.
– You are unemployed and collecting unemployment benefits.
Know how the withdrawal will affect your tax liability
All withdrawals from 401K, 403B, 457B and traditional IRA accounts are taxed as regular income upon withdrawal. It’s important to have your accountant or financial planner provide tax projections to prepare you for the tax consequences. To avoid underpayment penalties, make sure enough taxes are originally withheld.
Additionally, the tax implications may be tricky and it is prudent to have your tax professional involved early so you can avoid potential issues.
Keep in mind that Roth IRA accounts are funded with post-tax dollars so in the event of an early withdrawal earnings are taxed at regular income tax rates.
Know how to correctly apply for the withdrawal
Now that you have decided that borrowing from retirement plans to cover illness expenses is the best option for you, make certain you apply for it correctly. Specifically, communicate to the custodian of your account that the withdrawal is for hardship purposes – either medical expenses or permanent disability. This should be reflected properly on the 1099-R form you receive because of the distribution. If it is not, contact the custodian immediately and have them reissue a new 1099-R with the corrected code.