Changes Could Be Coming to Your 401(k) PlanTrevor Gerszt
The Republican tax reform bill has finally been introduced in the House of Representatives, allowing us finally to see what could be in store for us in the future. A much higher standard deduction, fewer tax brackets, and significant changes to tax credits have garnered many headlines. Less well-appreciated are the changes that could be coming to 401(k) plans if this bill makes it into law. Don’t worry, contribution limits haven’t been decreased as some people had initially feared. In fact, some of the changes that are coming to 401(k) plans could prove to be very beneficial.
Contributions After Hardship Withdrawal
Many 401(k) plans offer an option for a hardship withdrawal or a hardship loan. That means that there is some immediate and heavy financial need on the part of the account holder, who is then allowed to withdraw funds from the 401(k) account in order to meet that financial hardship. Some of the more common reasons for hardship withdrawals include paying for college tuition, making a down payment on a house, paying for medical expenses, or preventing foreclosure or eviction from a home.
Taking funds out via a hardship withdrawal will incur income taxes, plus a 10% tax penalty if you’re under 59½ years old. Some plans offer a hardship loan rather than a withdrawal, which allows you to take funds out and then pay them back, thus avoiding taxes and penalties.
Investors who currently take a hardship withdrawal from a 401(k) plan are forbidden from making contributions to their 401(k) plan for six months after taking the withdrawal. In many cases people forget to start up their contributions again after the six month period is over, or their employers fail to inform them that they can start contributing again.
The new tax plan eliminates that six month restriction, allowing investors to continue contributing to their retirement plans even if they have to take a hardship withdrawal. That’s important to ensure that employees don’t derail their retirement savings planning just because of a momentary hardship.
Larger Hardship Withdrawals
Current hardship withdrawal rules only allow 401(k) account holders to take hardship withdrawals of money they contributed, not money that they received through employer matching contributions or money they gained through investments. For instance, consider the case of an employee who contributes $500 per month to a 401(k), gets an equal employer match, and gets a return of 8% per year. After five years, he would have over $76,000 in his 401(k) account, but he would only be able to touch the $30,000 that he contributed in the event of a hardship withdrawal.
The new tax plan would open up employer matching contributions and investment gains for hardship withdrawals, making that entire $76,000 eligible. Given how many people were affected by natural disasters this year as a result of hurricanes and wildfires, and how many people have the bulk of their savings tied up in 401(k) accounts, it only makes sense to enable them to withdraw or borrow as much as they can to recover from catastrophic events.
Repaying 401(k) Loans If You Lose Your Job
Currently, an employee who loses his job or whose 401(k) plan terminates while he has an outstanding loan from his 401(k) plan has 60 days to repay that loan or roll it over into a new employer’s plan, otherwise it is treated as a distribution and will be subject to income taxes and penalties. Under the new tax plan, an employee in that situation would have until his taxes are due for that tax year to repay that loan. So an employee who lost his job in February would have until April 15th of the following year to repay that loan. That provides employees who lose their jobs a more realistic time frame for repayment or rolling over.
Distribution Age Synced Across All Plans
Currently, 401(k) plans allow employees to begin taking penalty-free distributions at age 59½. But some state and local government 403(b) and 457 plans only allow their employees to take penalty-free distributions at age 62. The new tax plan sets 59½ as the distribution age across all these various contribution plans.
Nothing Is Final
It’s important to remember that nothing is final yet. Legislation often undergoes many changes as it makes its way through Congress, and any of these details could be changed or eliminated during negotiations. And even though 401(k) contribution limits weren’t touched in the first draft of this legislation, that’s no guarantee that they won’t be modified in some way as this bill progresses, possibly even in the eleventh hour.
That’s why it’s incumbent upon 401(k) account holders to keep abreast of developments in Congress that might affect their retirement plans. And remember also that you can roll over your 401(k) assets into an IRA, such as a gold IRA. So if you don’t want Congress touching your 401(k) funds and messing up your retirement planning, you might do well to remember the rollover option should you end up needing it.