Hardship Distributions for Health Care

Health Care is Expensive

We’ve all heard stories of people who file for bankruptcy after spending all their savings paying for medical services for an advanced illness. A Forbes article explained how to access retirement funds for vital health care needs.

3 Steps to using Retirement Funds for Health Care

First, you have to know the kind of plan(s) you have because the rules vary from plan type to plan type. For example, “401k and 403b plans are very common and have similar rules” but each employer “decides whether to allow hardship distributions” when creating their plan(s). “Refer to the ‘summary plan description’ that is provided to you each year or ask your human resource department if hardship distributions are available. For these plans, the IRS requires that you access all other available distributions and loans from the plan first.” However “457b plans have a slightly stricter definition of when plans can be utilized for illness. Distributions are allowed only when a participant has an unforeseeable emergency, so a sudden diagnosis of a serious illness would fit that category. The employer has to prove that you have no other resources in place to meet your need, so they will ask for appropriate documentation from you. Again, your employer has the ability to determine whether they allow hardship withdrawals in the first place, so check with your human resources department.” If you are over 59.5 years, then you can dip into your IRA account without penalty. However, if you are younger there are 3 options:

  • “If disability is ‘total and permanent’ as determined by a physician, and you cannot work for at least a year, or the condition will result in your death, you are allowed to use money from your IRA penalty free.
  • If you have unreimbursed medical expenses above 10% of your adjusted gross income, you can pay for those medical expenses out of your IRA account. Have an accountant or financial planner run calculations for you.
  • If you are unemployed and drawing unemployment benefits, your IRA can be used to pay for health insurance premiums for you and your family.”

Once you know the type of plan you have, then you have to find out the tax implications of withdrawing those funds to cover health care costs. The most important tip is to contact your tax provider early in the process to make sure you are maximizing your benefits while minimizing your tax risks. The Forbes article states: “All withdrawals from 401k, 403b, 457b, and traditional IRA accounts are taxed as regular income upon withdrawal. Have an accountant or financial planner provide tax projections to prepare you for the tax consequences. Make certain you withhold enough taxes so you will not be subject to underpayment penalties.”

The final step is to apply for the withdrawal. Forbes’ says, “Make certain the withdrawal paperwork from your place of employment states the withdrawal is for hardship purposes…Because of the distribution, you will receive a 1099-R for tax purposes in January. Check this document immediately to make certain the distribution is coded correctly. Box 7 of the 1099-R should be marked with code 2 – early distribution, exception applies (under age 59 ½) or code 3 – disability. If the code is not correct, contact the custodian immediately and have them issue a new 1099-R with the correct code. If not corrected, the IRS will charge you a 10% penalty for the withdrawal.”

This is all great in theory, but if you have some practical experience, please share in the comments section below, or on our facebook page.

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