Q: My home sustained substantial damage from an earthquake that hit central Virginia. Homeowner’s insurance will not cover these costs, and so we have decided to use our retirement funds to help us complete the necessary repairs. What advice can you offer for how to go about accessing these funds?

Sincerely, Cracked Foundation

$ ?s answered by Matthew Illian, CFP^®

Dear Cracked Foundation,

I am very sorry to hear about the damage to your home. I’m assuming you have sought all other sources of capital before deciding to tap your 401(k). Pulling money out of a retirement plan is complicated. And it can often cause some unforeseen tax complications down the road, so you want to be careful.

The first step is to speak with someone who is knowledgeable about your specific plan. This will likely be a human resources (HR) 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 are having trouble finding someone knowledgeable to talk to, request a copy of the Summary Plan Document. This document will review all of your options.

A 401(k) loan is the first place you should look in a pinch. If available, the maximum you can borrow is the lesser of $50,000 or half of the vested account balance. Don’t let the interest charge alarm you because you will be paying yourself back during the repayment period.

The downside to loan repayment is that you will be using after-tax dollars to repay yourself. This means that your dollars have already been taxed and will be taxed again in retirement (double taxation).

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 avoid the penalty if you own a Roth IRA that you use as a conduit vehicle, but the federal and state taxation are unavoidable.

Seeking a hardship withdrawal 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 penalty.

To qualify for distribution, your hardship must qualify as “immediate and heavy” (you’ve got this covered), and it must be established that you have no other access to funds to meet this need. The vacation boat and the inherited gold coins should be used before you’re allowed to select this option.

The maximum that can be taken out on account of a hardship is typically the total amount of what an employee has contributed. And unlike loans, they do not need to be repaid to the plan.

This natural disaster does not also need to be a financial disaster. Your best bet is to start making small steps toward basic stability and then toward meeting your long-term goals.

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