Qualified Birth or Adoption Distribution 401k: What You Need to Know

You're expecting a baby or adopting a child, and you're wondering how it will affect your 401(k) plan. Congratulations on this exciting life event!

You can take a qualified birth or adoption distribution from your 401(k) plan, which allows you to withdraw up to $5,000 from your account for qualified expenses.

This type of distribution is tax-free and penalty-free, meaning you won't have to pay income tax or a 10% early withdrawal penalty.

You can use the funds for qualified expenses, such as pregnancy-related medical expenses, adoption fees, and birth-related expenses.

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A Qualified Birth or Adoption Distribution (QBOAD) is a special option that allows employees to take money out of their 401(k) retirement account to help with the costs of having a child.

This option became available on January 1, 2020, thanks to the Setting Every Community Up for Retirement Enhancement (SECURE) Act.

Up to $5,000 per parent per child can be taken from a 401(k) or other eligible retirement plan without paying the 10 percent early distribution penalty.

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To qualify, the distribution must be taken during the 1-year following the date when the child is born or the date when the legal adoption is finalized.

The amount of the distribution is reported as gross income for the year and taxes must be paid on it.

This can mean significant federal and state taxes, depending on an individual's income tax bracket.

An employee who takes the distribution can pay it back, but no time frame has yet been set by the Treasury Department for the repayment.

Missing out on investment gains is a consideration if the money is delayed in being replaced.

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A qualified birth or adoption distribution from a 401k can be triggered by the birth or adoption of a child, which also qualifies as an exception to the 10 percent early distribution penalty tax.

This exception is effective for distributions in 2020 and later years, and it applies to Internal Revenue Code Section (IRC Sec.) 401(a) plans, 403(a) annuity plans, 403(b) plans, governmental 457(b) plans, and IRAs.

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The distribution must occur within one year of the birth or when a legal adoption is final, and qualified birth or adoption distributions may not be made from defined benefit pension plans.

To qualify, 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, which applies on a per individual basis.

This means that each parent can distribute up to $5,000 from their own account for the birth or adoption, and an account owner may receive distributions for multiple births or adoptions.

For example, if you give birth to twins, you may take up to $10,000 ($5,000 for each child) from your eligible retirement plan or IRA as a qualified birth or adoption distribution.

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If you're taking a qualified birth or adoption distribution from your 401k, you'll need to report it to the IRS. The distribution is reported on IRS Form 1099-R, which will show the type of distribution you received.

If you're under 59½, the distribution codes in Box 7 will be different from those for people 59½ or older. For under 59½, the distribution codes are Code 1 for an early distribution, Code 1 and B for a designated Roth account distribution, or Code J for an early distribution from a Roth IRA.

To claim an exception to the 10 percent early distribution penalty tax, you'll need to complete IRS Form 5329. This is done when you file your federal income tax return.

The good news is that if you're eligible, you 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, or to an IRA.

Here are the distribution codes for people 59½ or older:

The SECURE Act made some significant changes to 401(k) plans, and one of the most interesting is the Qualified Birth Or Adoption Distribution (QBOAD). This provision allows employees to take up to $5,000 per parent per child from a 401(k) or other eligible retirement plan without paying the 10 percent early distribution penalty.

The QBOAD took effect on January 1, 2020, and the IRS issued guidance for employers in September 2020. This guidance is available on the IRS website at www.irs.gov/pub/irs-drop/n-20-68.pdf.

To qualify for the QBOAD, the distribution must be taken during the 1-year following the date when the child is born or the date when the legal adoption is finalized. Employees must report the amount of the distribution in their gross income for the year and pay income taxes on it.

The amount of the distribution could mean significant federal and state taxes, depending on an individual's income tax bracket. Employees who take the distribution can pay it back, but no time frame has yet been set by the Treasury Department for the repayment.

If an employee changes jobs after taking a QBOAD, they may be able to make their recontribution into a personal IRA.

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