Wednesday, November 21, 2012

Hurricane Sandy Hardship Withdrawals

(Despite a comment on my last post, this blog has not been "shut down", but blogging is rather slow.  I make no apologies, I've been running around like I can't remember when.  Nonetheless, hopefully I will get some posts up, especially a short and timely right now).

On Friday, November 16, the IRS put out a late Announcement 2012-44 regarding hardship withdrawals from 401(k), 403(b), and eligible 457(b) plans.  Lest anyone be baffled by the alphabet soup, these are retirement plans for private industry and non-profit or governmental agencies.  Each of these plans allow for loans and withdrawals under certain conditions and the announcement eases some of the requirements for documentation and other requirements for both businesses and victims.  Those outside the disaster area but with a child, parent, grandparent, or dependent in a hardship area may also take loans or distributions with less red tape.  Hardship withdrawals based on "unforeseeable emergency" for those is defined geographic areas can be made between now and February 1, 2013.

Lest anyone get too excited and run to withdraw money (with such a need for funds, it is easy to jump head first), let's just consider a few things:

*The IRS has not lifted the 10% penalty for early withdrawal.  When the announcement came to my email box late Friday before candle lighting, I almost assumed it was easing the penalty as well as documentation requirements.  I revisited the subject today and there will be a penalty to withdraw.

*Does that mean someone should not make a withdrawal?  Well, not particularly.  While I generally oppose dipping into a retirement funds and searching for other solutions to cash crunches, having seen photos of the terrible destruction and knowing how many families need to get back onto their feet and will need money to do so even with all of the wonderful chessed that is being done to alleviate the devastation, there are very good arguments for those have saved for retirement to dip into available funds despite the additional 10% penalty if that is the best solution after considering their big picture.

*Something to consider is the timing of the withdrawal(s) if you choose this route taking part of the withdrawal in 2012 and 2013.  Remember that when you take money from a retirement plan such as a 401(k) before age 59 1/2, you owe tax at your highest marginal rate (federal and state/local) in addition to the 10% penalty.  It might make sense to consider withdrawing some for this year and some next year.  

Remember to consult someone for professional advice before making this decision.  This blog post is informational, not authoritative.  


Mr. Cohen said...

I am happy to see that Orthonomics has returned; it is one of the most important blogs for Orthodox Jews.

Avi Greengart said...
This comment has been removed by the author.
Avi Greengart said...

Taking a 10% hit and setting back retirement planning certainly makes better financial sense than going into debt by putting things on a credit card at 17% interest. But can I assume you would only recommend this approach for people who have major property damage and need to supplement FEMA and insurance payments? I suspect you would agree that Sandy should not be used as an excuse to withdraw retirement money to make a big wedding, visit relatives in Israel or buy [insert your particular community's "necessity" here].

Mark said...

I wonder if taking a loan from the 401k is a better option? I'm surprised that they aren't relaxing the 10% penalty in this case.

Also, they may be some low interest loans available via FEMA (sometimes via SBA for some odd reason) that are generally worthwhile because they are very low interest and usually don't and the associated paperwork.

Conservative scifi said...

I would NOT recommend taking a loan from a retirement account for this reason (or almost any reason). FEMA offers loans (and even grants), and the loans can have interest rates as low as 1.68% (which is effectively almost free).

If you borrow from your retirement account, you will pay a 10% penalty on money which will also be subject to ordinary income tax. You will then have to repay it over the next few years with AFTER-TAX money and if the market goes up, you'll miss out (though you might avoid a decline). Also, if heaven forbid you lose your job, you might have to pay the entire sum back in lump sum form. Also, while the money is in a retirement plan, it is substantially shielded from bankruptcy, spousal debt, etc., but once you remove the money, it can be grabbed if you owe such debts.

Dave said...

Borrowing from a 401k does not get you the 10% penalty, or income tax penalty.

Failure to repay it (which yes, you have to do in full if you change jobs), would be subject to that penalty (which would be taken from the remainder of your 401k, if I recall correctly).

Conservative scifi said...

Dave's right. I was concerned about the situation if you lost or changed jobs during the life of the loan (which might be more likely due to the Hurricane).

Anonymous said...

I've heard that the principal in a Roth IRA can be withdrawn tax free and w/o a penalty.

Is that right?

Mark said...

Yes, previous contributions to your Roth IRA may be withdrawn without any tax or penalty.

Abacaxi Mamoa said...

Withdrawals from a Roth IRA are tax-free because you put post-tax money into them. You already paid income taxes on that money.