Should New Parents Take Advantage of the SECURE Act's Exemption?

From childbirth delivery to clothing, childcare and more, new parents face diverse costs when welcoming a new life into the world. Before raising their child, parents with insurance will already have to pay an average of $4,500 for labor.¹ Subsequently, during the first year of a child’s life, on average parents spend between $12,350 and $13,900.²

Whether you’re a soon-to-be parent or are just entering parenthood, you’re likely taking a look at your financial picture. Integrating your short- and long-term financial goals with the immediate needs of raising your child can feel complicated. Additionally, some parents may still be saddled with student debt, and many are aiming to regularly invest in their future retirement.

Even with adequate income available, many new parents still wonder how to approach financially supporting life with a new baby. The recently passed SECURE Act’s exemption is one way to receive financial assistance as a new parent. Below we explain the details of this new exemption, and we go through the main pros and cons of taking the withdrawal.

How Does the SECURE Act Help New Parents?

The SECURE Act, which passed at the end of 2019, enables every new parent to withdraw up to $5,000 penalty-free from an eligible retirement plan during the first year of birth or adoption to cover qualified expenses. This means that a couple is collectively eligible for up to $10,000 of support if each parent has a separate retirement account.³

The Pros

Pro #1: It’s a Penalty-Free Opportunity

Individuals who take an early distribution from a 401(k) or IRA will typically face a 10 percent penalty in addition to income tax.⁴ Another avenue through which you can use your retirement funds is through a retirement plan loan that must be paid back, usually within five years.⁵

The SECURE Act, however, now offers an opportunity for parents to withdraw funds without facing the 10 percent penalty or taking the money out as a loan (with the requirement to pay it back).³ In this way, new parents can decide whether or not — and how quickly — they would add funds back into their accounts, depending on their financial situation.

Pro #2: New Parents Can Avoid Falling into Debt

If you don’t have adequate savings available to cover necessary short-term costs for your child, opting for this withdrawal may prevent you from sliding into debt. Other alternatives for covering vital first-year expenses include a credit card or personal loan, which may have high-interest rates. Since the $5,000 withdrawal is not money borrowed, new parents do not need to worry about accruing interest over time. In this way, if you’re in need of extra funds, the penalty-free withdrawal could be a financially sound choice compared to other available options.

The Cons

Con #1: The Withdrawal is Still Taxed

While you won’t owe the 10 percent penalty for this specific type of withdrawal, you'll still owe income taxes for any funds taken out. This means your household could be subject to additional taxes on up to $10,000.⁶

Con #2: Taking Out Money Could Reduce Returns

Utilizing funds from your retirement account can decrease the possibility that you’ll have enough to experience the post-career years you’ve envisioned. $5,000 can compound over time to yield thousands of additional dollars. By taking any amount from your account, there is a likelihood that you will miss out on greater returns.

Alternative Financial Moves for New Parents

If you’re looking to secure your financial situation as you adjust to being a new parent, there are several ways to do so, other than opting for the SECURE Act’s exemption:

Establish a household budget
Claim your child as a dependent
Take advantage of Health Savings Account (HSA) contributions
Create an emergency fund
Adjust your health insurance to include your child

Deciding whether or not to take advantage of the SECURE Act’s exemption is reliant upon the financial situation of a parent or couple and their other options available. In addition, some accounts and employers have not yet enacted this exemption. Reviewing the details of your specific plan and taking a look at your financial portrait will help you figure out if this exemption is the right move for you.

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

Paradigm Advisors is a fee-only financial planning firm based in Dallas, Texas and Fayetteville, Arkansas. Paradigm Advisors provides comprehensive financial planning and investment management services to help clients organize, grow and protect their wealth throughout life’s journey. Paradigm specializes in advising young professionals and entrepreneurs in the early stages of life and well-established career executives through financial planning and investment management. As a fee-only fiduciary and independent financial advisor, Paradigm never receives commission of any kind. Paradigm is legally bound by certification to provide unbiased and trustworthy financial advice.