New Qualified Birth or Adoption Exception
By Alexis Gonzalez-del-Valle, CIP, CHSP
The birth or adoption of a child is a major life event—and often an expensive one. But starting in 2020, your IRA and retirement plan clients who are experiencing this major life event may have an opportunity that they didn’t have before. The Setting Every Community Up for Retirement Enhancement (SECURE) Act, part of the Further Consolidated Appropriations Act enacted December 20, 2019, contains several provisions affecting retirement plans and IRAs. One of these is an excise tax exception for qualified birth or adoption distributions—a way for your clients to reduce some of the financial burden that comes with the birth or adoption of a child.
Both a Triggering Event and a Penalty Exception
Effective for distributions in 2020 and later years, the birth or adoption of a child qualifies as a retirement plan distribution triggering event and as an exception to the 10 percent early distribution penalty tax for Internal Revenue Code Section (IRC Sec.) 401(a) plans, 403(a) annuity plans, 403(b) plans, governmental 457(b) plans, and IRAs. To qualify, the distribution has to occur within one year of the birth or when a legal adoption is final. Qualified birth or adoption distributions may not be made from defined benefit pension plans.
For a distribution to be treated as a qualified birth or adoption distribution, the account owner must include the name, age, and taxpayer identification number of the child or eligible adoptee on the account owner’s tax return for the year in which the distribution is made. The maximum qualified amount that an account owner can distribute for each birth or adoption is $5,000. This distribution limit applies on a per individual basis; thus, each parent can distribute up to $5,000 from his or her own account for the birth or adoption. An account owner also may receive distributions for multiple births or adoptions. For instance, if your client gives birth to twins, that client may take up to $10,000 ($5,000 for each child) from her eligible retirement plan or IRA as a qualified birth or adoption distribution.
An eligible adoptee is anyone (other than the child of the account owner’s spouse) who has not attained age 18 or is physically or mentally incapable of self-support. This self-support determination is made in the same way as the determination of whether an individual is disabled under IRC Sec.72(m)(7). Under IRC Sec.72(m)(7), the individual is deemed to be disabled if that individual cannot engage in any substantial gainful activity due to physical or mental impairment that can be expected to result in death or to be of long-continued and indefinite duration.
Plan Permitting
An eligible retirement plan is not required to allow in-service distributions for qualified birth or adoption events. If the plan does allow them, then the plan sponsor or plan administrator may rely on the plan participant’s reasonable representation that he is eligible for a qualified birth or adoption distribution, unless the plan sponsor or the plan administrator has knowledge to the contrary.
For eligible retirement plans to permit qualified birth or adoption distributions, employers must adopt what is considered a discretionary amendment. The deadline for employers to adopt the amendment is the end of their 2022 plan year (2024 for governmental and collectively-bargained plans).
For eligible retirement plans that permit qualified birth or adoption distributions, they must also accept the recontribution of such amounts if all of the following apply.
The plan allows for qualified birth or adoption distributions.
The participant received a qualified birth or adoption distribution from that plan.
The individual is eligible to make a rollover contribution to that plan at the time that the individual wants to redeposit the qualified birth or adoption distribution.
Although qualified birth or adoption distributions may be repaid to an eligible retirement plan, they are not considered eligible rollover distributions for other purposes. As a result, the plan administrator does not have to
offer to directly roll over the assets;
provide a 402(f) notice;
withhold 20 percent of the distribution amount for federal income taxes.
These distributions, however, are subject to the voluntary federal income tax withholding requirements.
Qualified birth or adoption distributions are deemed to satisfy the distribution restrictions for 401(k) plans, 403(b) plans, 403(b)(7) plans, and governmental deferred compensation plans under IRC Sec. 457(d)(1)(A). For instance, an employer may allow an elective deferral, qualified nonelective contribution, qualified matching contribution, or safe harbor contribution under a 401(k) plan to be withdrawn as a qualified birth or adoption distribution, even if it is removed before a permitted distributable event (i.e., attainment of age 59½, disability, or severance from employment).
If the plan does not permit qualified birth or adoption distributions, then the plan participant who receives an in-service distribution that satisfies the requirements of a qualified birth or adoption distribution may treat the distribution as such on her federal income tax return. She may deposit that amount to an IRA if she wishes to do so.
IRS Reporting
Distributions for qualified birth or adoption expenses are reported on IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. If the account owner is under age 59½, the distribution codes to be entered in Box 7 are as follows.
Code 1, Early distribution, no known exception, if taken from a Traditional IRA, SIMPLE IRA, “SEP IRA,” or an eligible retirement plan with pretax and after-tax assets
Codes 1 and B, Designated Roth account distribution, if taken from designated Roth account assets in an eligible retirement plan
Code J, Early distribution from a Roth IRA.
The account owner claims the exception to the 10 percent early distribution penalty tax by completing IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, when he files his federal income tax return.
If the account owner is age 59½ or older, the distribution codes to be used are as follows.
Code 7, Normal distribution, if taken from a Traditional IRA, SIMPLE IRA, “SEP IRA,” or an eligible retirement plan with pretax and after-tax assets
Codes 7 and B if taken from designated Roth account assets in an eligible retirement plan
Either code Q, Qualified distribution from a Roth IRA, or code T, Roth IRA distribution, exception applies, as applicable.
The account owner generally can repay all or a portion of a qualified birth or adoption distribution in one or more contributions to the eligible retirement plan from where it was distributed (if the individual is otherwise able to make rollover contributions to that eligible retirement plan) or to an IRA, as permitted by the IRS. Repayments made to an IRA are reported on IRS Form 5498, IRA Contribution Information. Financial organizations enter any repayment amounts in Box 14a, Repayments, and Code BA in Box 14b, Code.
Additional Guidance Needed
At the time of this writing, no further guidance had been released as to whether there is a repayment deadline for qualified birth or adoption distributions. The statute implies that there is not a repayment deadline, but more guidance is expected.
In the meantime, the information provided here will be a helpful resource when working with your IRA and retirement plan clients as they begin inquiring about this new distribution option.
