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When your home sustains substantial damage from a natural disaster like a tornado, earthquake or hurricane, homeowner’s insurance rarely covers all the costs. Perhaps you have decided to use some of your retirement funds to help complete the necessary repairs. But how do you access the funds, and what are the implications?

If you have any other available funds, tap these first. Pulling money out of a retirement plan is demoralizing and it can often cause some unforeseen tax complications later on, so you want to be careful.

Borrowing From Your 401K

An emergency loan from your 401K could be the next place to look in a pinch. Before you try to access your 401K funds, the first step is to speak with someone knowledgeable about your specific plan. Contact a human resources officer, or you may be directed to call a service representative at the plan’s record keeper. It will not help to talk to the IRS or search the Internet for answers because each retirement plan has its own rules for distributions.

If you don’t get much help, request a copy of the Summary Plan Document, which will review all of your options for accessing funds before retirement.

If available in your plan, the maximum you can borrow is the lesser of $50,000 or half the vested account balance. You’ll pay interest on the money you borrow, which isn’t as bad as it might first sound. Loans plus interest get paid right back into your own account. But the interest undergoes double taxation. You repay this interest with after-tax dollars and then pay tax again when you make a distribution from the plan in retirement.

Hardship Withdrawals

Some plans offer in-service withdrawals of vested account balances. These withdrawals for people younger than age 59½ incur both tax and a 10% penalty. You may be able to escape the penalty if you utilize a conduit Roth IRA strategy but the federal and state taxation are unavoidable.

Seeking a hardship withdrawal — which is different from taking out a loan — should be your final option. You will be prohibited from making any contributions to the plan for six months after a hardship withdrawal, and you should expect to pay both tax and the 10% penalty.

To qualify for distribution, your hardship must qualify as “immediate and heavy” which applies to most any natural disaster. And it must be established that you have no other access to funds to meet this need. That is, the vacation boat and inherited gold coins must be liquidated before you’re allowed to select this option.

The maximum that can be withdrawn because of a hardship is typically the total amount of what you have contributed as a participant. Employer matching funds and account earning are usually not available. Unlike loans, hardship withdrawals do not need to be repaid to the plan.

A natural disaster does not have to become a financial disaster. Be careful where you seek help, and be sure to do your homework when it comes to picking a financial adviser. Consider working with a fiduciary adviser who is legally bound to put your needs first as you take steps to recover from a temporary setback and resume your journey to financial freedom.

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