Child Birth and 401K Roth Hardship

[tlminjar]

I have a child due later this year and my employer doesn't offer any sort of paid maternity leave or short-term disability, I am allowed to do a hardship from my Roth 401K without penalty according to ADP.

What sort of documents would be needed to show proof of birth, for tax purposes or for an audit?

What are the requirements specifically for birth of a child hardship?

Are they the same as every other hardship? 

If my Roth has already been taxed, will I be taxed again on the hardship withdrawal?

[tagteam]

Please check later. I will page @dmertz.

[dmertz · Accepted solution]

This question about what documentation is required can only be answered by the plan because it's up to the plan to accept the reason that you qualify to obtain a hardship distribution.

A distribution received before the date of the birth will not qualify as a Qualified Birth or Adoption Distribution.  Distributions from a Roth 401(k) are a proportionate mix of contributions and earnings.  The proportion that is earnings will be subject to income tax and early-distribution penalty (unless you have some other penalty exception that applies, which seems unlikely).

[Opus 17]

So, there are two different things going on here.

First:

401k plans may allow hardship withdrawals (they don't have to).  If they do, then the type of hardship allowed and the proof required is up to the plan.  You won't be audited for the early withdrawal, but the plan could be audited, so ask them what kind of proof they want.

Your Roth 401k contributions were already taxed, but the earnings were never taxed, and if you withdraw earnings before age 59-1/2, you will pay regular income tax on the earnings.  As @dmertz indicated, your withdrawal will be a mix of earnings and contributions, and only you or your plan can guess at what the ratio will be.  You should ask your plan before making the withdrawal.

As a rough estimate, suppose you have contributed $50,000, and the balance is $100,000.  Since 50% of the balance is non-taxable earnings, 50% of any withdrawal will be non-taxable, and the other 50% will be taxable plus a 10% penalty.

Second:

If you withdraw money after the child is born, you are exempt from the 10% penalty for early withdrawal for the first $5000 of taxable earnings that you withdraw.  Here, the exemption is up to you, not the plan, so you would probably need a birth certificate if audited.  

In the example above, suppose you withdraw $20,000, and $10,000 is taxable.  If you make the withdrawal after the child is born, then you would pay income tax plus 10% penalty on $5000, and income tax only (but no penalty) on the other $5000.  The penalty exemption is not allowed if the money is withdrawn before the birth, so you might want to wait, or to split up your withdrawal into some before and some after. 

[tlminjar]

I definitely had no intentions of pulling prior to the baby being born, I just want a full understanding of what I needed when the time came. I think I am still confused as to why I am taxed twice on my 401k. No employer contributions are made to it, it’s all money from my pay check. I need a better understanding of why I am taxed twice. 

[Opus 17]

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@tlminjar wrote:

I definitely had no intentions of pulling prior to the baby being born, I just want a full understanding of what I needed when the time came. I think I am still confused as to why I am taxed twice on my 401k. No employer contributions are made to it, it’s all money from my pay check. I need a better understanding of why I am taxed twice. 

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With a Roth 401k, you contribute after-tax dollars, but the investment growth is tax-free.  If you wait until retirement to withdraw funds, that growth is still tax-free, but if you withdraw the growth (increase) before age 59-1/2, that increase is taxable.

It's similar to how, if you invested after-tax money with a stock broker, you would only pay tax on the gains/growth (interest, dividends, and increased stock value).  The special thing about a Roth 401k is that withdrawals are completely tax-free if you wait for retirement—but the growth is still taxable if you withdraw before retirement.

A Roth 401k has different rules on taxing withdrawals before age 59-1/2 than a Roth IRA, it's how the laws were written.  With a Roth 401k, your withdrawal before retirement contain a proportional amount of contributions and gains, so you pay income tax on the portion that is gains.