Considering Taking a Hardship Distribution from Your Retirement Plan?

The coronavirus pandemic is leaving millions of Americans on furlough or out of a job, dealing with reduced hours or workload… but NOT with reduced monthly bills to pay. For many, this is a time of financial hardship. Sadly, according to a 2018 Federal Reserve report, 40 percent of adults cannot cover a $400 emergency expense and the current situation goes far beyond that.

Sometimes, individuals consider dipping into one’s retirement plan to cover short-term expenses. Among the emergency expenses that may qualify for such a withdrawal are tuition/education expenses; down payment or repairs on a primary residence, rent or mortgage payments (to thwart possible eviction or foreclosure); out-of-pocket medical expenses; and funeral costs.

Historically:

• The withdrawal amount has been limited to the amount of the emergency expense
• The plan participant pays income tax on the withdrawal plus a 10 percent penalty if under 59½ years old
• If a 401(k) design allows for loans (not all do), people taking loans against their 401(k) plans must repay the full loan amount with interest; lack of repayment can trigger additional penalties
• In addition, participants’ contributions from their paychecks into their 401(k) plans are suspended for at least six months after taking the hardship distribution

Changes with the CARES Act

This stimulus package has loosened the rules around taking hardship withdrawals from retirement plans, and loans from 401(k) plans. A CARES Act provision allows individuals who are facing adverse financial consequences due to COVID-19 to withdraw funds from their retirement accounts without penalty (regardless of age). This applies to IRAs and 401(k) plans.

The withdrawal must be made before December 31, 2020 and can be up to $100,000. Tax payments on this income are extended out three years. For those taking loans against their 401(k)s, that amount is also raised to $100,000. Note that there are no loans from IRAs.

Why gamble with your retirement savings?

Many financial experts argue against taking out a hardship loan from one’s 401(k) plan to avoid reducing any retirement savings, when there are other loan options available (such as a home equity loan, SBA loan, or other lines of credit). And, all good intentions aside, it may be difficult to replace the funds from a hardship distribution from an IRA or other retirement plan—and then rebuild on that money for retirement.On top of that, the stock market has suffered a tremendous downturn, with subsequent volatility almost daily, as a result of COVID-19 and the economic stressors stemming from lockdowns.

Weathering market volatility through self-direction

Self-directed investors have greater leeway when it comes to hedging against that stock market volatility. That’s because of the many alternative assets that can be held in a self-directed retirement plan. Investing in real estate, precious metals, private equity, or other non-publicly traded assets give savvy investors many more ways to build a more diverse retirement portfolio that have stronger potential to weather the COVID-19 storm (and other times of economic uncertainty). One reason is because the returns on nontraditional investments in a self-directed IRA do NOT directly correlate with stock market returns.

You can even loan funds from your self-directed IRA to someone who is dealing with a cash flow shortage, with the terms worked out between both parties, and receive interest and principal paid back to your IRA.

As always, it is best to consult your trusted financial adviser about how to navigate financial hardship as it relates to your retirement plan. At Next Generation, we’re here to answer any questions you have about self-direction as a retirement strategy, or about the many alternative assets allowed in these plans. You can schedule a complimentary educational session to learn more or contact us directly via phone at 888.857.8058 or email NewAccounts@NextGenerationTrust.com.

You Can Take it With You – Use Your 401(k) to Fund Your New Self-Directed IRA

Analysts forecast that within the next five years, assets held in IRAs will nearly double those in 401(k) plans, with IRA assets growing to $12.6 trillion by the end of 2022—up from $9.2 trillion at the end of last year. Assets in 401(k)’s in the US. are estimated to reach $6.6 trillion by 2022, up from $5.3 trillion last year. These figures are according to Jessica Sclafani, director of the retirement practice at research firm Cerulli Associates.

Sclafani cited that a major source of this growth is rollovers from 401(k) plans–nearly all (96%) of the $2 trillion total IRA contributions from 2012 to 2017 came from rollovers from defined contribution plans. That, and contributions to IRAs (mainly due to rollovers) have exceeded distributions from them in recent years. In fact, IRAs became the largest segment of the US retirement market in 2013. Sclafani attributes much of this rollover activity to the lack of flexibility in workplace plans with distributions. Because of this, participants are looking for more flexible arrangements.

It’s not surprising to learn that 401(k) plans have not enjoyed the same organic growth; in recent years, distributions exceeded contributions, and the primary driver behind 401(k) asset growth has been market performance.

Roll over your 401(k) assets into a self-directed plan

When you open a self-directed IRA, one way to fund it is cash. Another is to transfer funds, or you can rollover funds from an eligible 401(k) plan. Doing this will open doors to a wider pool of investments, since self-direction allows for many alternative assets not allowed in typical retirement plans.

A rollover occurs when funds are moved from a custodian as a distribution (a taxable event) and are received by the new custodian (like Next Generation) as a rollover contribution. It is a movement of funds between non-like plans, such as 401(k) to an IRA. You may open a self-directed Traditional, Roth, SIMPLE or SEP IRA, using the starter kits on our website. Keep in mind, though, that rollovers from an IRA to another IRA are generally limited to 1 (one) per 12-month period (this excludes direct transfers and Roth conversions). You must also contact your current custodian and have them initiate the rollover. Our helpful video about transfers and rollovers should answer any of your basic questions.

Do you have a 401(k) that’s returning lackluster results or one that’s stuck in a traditional brokerage investment vehicle?

Are you looking for the flexibility and freedom you need to include alternative assets in your retirement plan? When you’re ready to roll (over), you can download our rollover form or contact Next Generation for help getting your self-directed IRA set up, properly funded, and ready for investing in alternative assets. Contact us at 1.888.857.8058 or NewAccounts@NextGenerationTrust.com with any questions.