Hit Hard by Hurricane? Tapping Your 401(k) May Not Be a Great Idea
The IRS recently relaxed some rules related to hardship distributions from retirement accounts to make it easier and faster for hurricane victims to get money. However, hardship distributions come with costly strings attached.
![](https://cdn.mos.cms.futurecdn.net/U9HKAdoSxWxHcc84QhJy37-415-80.jpg)
The recent hurricanes in Texas, Florida and Puerto Rico have been devastating. Recovering from the storm damage is a daunting, and potentially very expensive, task. Those without robust emergency savings accounts are facing some tough decisions about where to find the resources to pick up the pieces. One place people may be looking at is their retirement plan, but that could be a big mistake.
The IRS has announced the removal of restrictive rules and procedures for withdrawals from employer-sponsored retirement plans (e.g., 401(k) and 403(b) plans) for hurricane victims. The removal of these hurdles will make it easier for these individuals, and their relatives who can take distributions from their own plans, to withdraw funds to pay for damages and related expenses. But that doesn’t mean you should do it.
The relief provided only relaxes the procedural and administrative rules related to withdrawals. It does not provide any tax relief. The IRS has stated that these withdrawals will still be subject to income tax and, if applicable, penalties. Even with the ability to access these funds, retirement plan participants affected by the hurricanes should strongly consider exhausting other funds first, and should use hardship withdrawals from retirement plans as an absolute last resort.
![https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-200-80.png](https://cdn.mos.cms.futurecdn.net/hwgJ7osrMtUWhk5koeVme7-320-80.png)
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Qualifying for Hardship Distributions
The special rules the IRS announced are designed to help people who need emergency funds get them faster than they normally would.
The rules for obtaining hardship withdrawals, in general, can be substantial. Normally, the only way for an employee to obtain a withdrawal from an employer-sponsored retirement plan is for it to qualify as a hardship withdrawal or to take a loan, except for unique cases.
Although hardship withdrawals and loans are permitted by the IRS, plans are not required to provide them. Someone who wants to take a hardship withdrawal would need to check with a benefit or plan administrator to see if the plan allows for it. Many plans do not.
Even if hardship withdrawals are permitted, they are allowed only for an “immediate and heavy financial need” and are limited to the amount necessary for that need. Not all expenses qualify. For example, funds to provide for temporary housing and food will likely not qualify, while money needed to repair damage to the employee’s home will. The IRS also requires that the plan sponsor retain thorough documentation.
Downsides of Hardship Distributions
What’s more, hardship distributions are subject to income taxes, unless they consist of Roth or after-tax contributions. Each dollar withdrawn from a retirement plan is generally taxed as ordinary income. Withdrawals may also be subject to a 10% penalty on early distributions, for those under age 59½.
In addition, hardship withdrawals put a permanent dent in your retirement account, because employees who take them cannot later repay them to the plan or roll them over to another plan or an IRA. And those who take a hardship distribution are banned from being able to make additional contributions to the plan for a six-month period. The effect of those restrictions is worsened by the loss of compounding growth for the amount withdrawn.
A Better Choice: Borrowing from Yourself
Hopefully, you have a robust savings account for emergency situations. If not, a better option than obtaining a hardship withdrawal might be to a take loan from the plan. The law allows you to borrow up to $50,000, or half your vested balance, whichever is less. Loans, though, typically need to be repaid (with interest) within five years to your account. And if you lose your job, they need to be repaid immediately, something to really think about if you’re in an industry where layoffs are common.
One big advantage of taking a loan from your retirement account is that when you pay it back, you’re paying yourself back. When you’re done, your retirement account is made whole again, and the growth you’ll see from compounding will be magnified because of it.
Conclusion
Although the IRS has provided special rules that make it easier for hurricane victims to obtain hardship distributions from an employer retirement plan to pay for expenses and repairs, such withdrawals should be made very thoughtfully. This is especially true since the IRS did not provide any tax relief for these types of distributions. If possible, use other sources of funds first, and then take loans from retirement plans.
The damage from the hurricanes has been immense. Don’t allow this disaster to damage your retirement, too.
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Daniel Fan serves as the Director of Wealth Planning for First Foundation Advisors. Mr. Fan is a Certified Financial Planner™ and holds his Juris Doctorate and Master's in taxation from Pepperdine University School of Law and Golden Gate University respectively. He earned his Bachelor's degree from the University of California, Los Angeles.
-
Visa Is the Worst Dow Stock Wednesday. Here's Why
Visa stock is down sharply Wednesday after the credit card company came up short of revenue expectations for its fiscal Q3.
By Joey Solitro Published
-
Another Analyst Moves to the Sidelines on Tesla Stock After Earnings
Tesla stock is spiraling Wednesday after the EV maker's big earnings miss and Wall Street has been quick to weigh in. Here's what you need to know.
By Joey Solitro Published
-
Confused by Annuities? Making Sense of the Different Types
Many investors aren't sure if annuities are a good option for meeting financial goals. Let's look at the different categories, along with their pros and cons.
By Kris Maksimovich, AIF®, CRPC®, CPFA®, CRC® Published
-
Talkin' 'Bout My Generational Wealth: Baby Boomers
With retirement, each generation has different priorities and challenges. For Baby Boomers, it's a matter of ready or not, here it comes.
By Alvina Lo Published
-
How to Avoid a Big Hassle if Your Financed Car Gets Wrecked
How an insurance check is made out for repairs can cause a world of problems if the lienholder is left out.
By H. Dennis Beaver, Esq. Published
-
Estate Planning Strategies to Consider as Election Nears
Are big changes in tax laws coming soon? Not likely, but you might want to take advantage of higher estate and gift tax exemptions well before the end of 2025.
By David Handler, J.D. Published
-
How to Get Your Money's Worth From Your Financial Adviser
A good financial adviser will focus on how your financial planning and investment strategy align with your lifestyle and aspirations.
By Pam Krueger Published
-
Think of Prenups and Postnups as Financial Planning Tools
These contracts provide a clear framework for asset management and protection and are especially useful if you get married later in life.
By Andrew Hatherley, CDFA®, CRPC® Published
-
Congratulations on Your Raise: Three Things to Do With It
We're not saying you shouldn't spend it on a new car, but there are some considerations to guard against lifestyle creep and to help ensure a comfy retirement.
By Andrew Rosen, CFP®, CEP Published
-
Check Off These Four Financial Tasks to Finish 2024 Strong
The new year is a popular time to set financial goals, but now is the ideal time to check how you're doing. Four tweaks could make a big difference.
By Daniel Razvi, Esquire Published