It’s bad enough to tap your 401(k) when you are unemployed. But should you have to pay a 10 percent early distribution penalty too?
Not if a little-known provision buried deep within President Barack Obama’s proposed 2016 budget becomes law. The provision would allow those who’ve received unemployment compensation for more than 26 weeks to withdraw up to $50,000 per year from their IRAs and employer-sponsored retirement plans.
And while experts said the budget is unlikely to pass in its current form, there appears to be bipartisan support for the exemption.
Under the proposal, you would have to withdraw retirement funds either in the year when you received unemployment compensation or the following year.
If you qualify, you can withdraw at least $10,000 from your retirement accounts. If you have more than $10,000 in your retirement accounts, you can withdraw half of your retirement plan balance up to $50,000 penalty-free.
Here’s how the exemption would work: If you have $30,000 in your retirement accounts, you can only withdraw $15,000 from your nest egg without paying the 10 percent penalty. You would need at least $100,000 in your retirement accounts to receive the full $50,000 distribution without paying the penalty.
But it will be hard to make up a huge withdrawal from your retirement accounts. You can only contribute $5,500 (or $6,500 if you’re 50 or older) per year to an IRA. The contribution limit for 401(k)s is $18,000 this year (or $24,000 if you’re 50 or older). Not to mention the potential earnings you might miss by taking out money from your retirement funds.
Many taxpayers under financial hardship have fought the 10 percent early distribution penalty in court and failed to gain relief. “It’s just a case you can’t win, even though the court often sympathizes with those taxpayers. The law needs to change,” says Jeffrey Levine, an IRA technical expert with Ed Slott & Co.
But lawmakers don’t want to be seen as adding to the financial burden of the unemployed. That gives Levine hope that the hardship exemption for retirement plans might gain bipartisan support from Congress.