Yahoo Finance How to Cash in Your Retirement Plan for Medical Bills
A sudden illness or health mishap can affect your financial health just as much as your physical health.
One in five U.S. consumers has medical debt on their credit report, according to a 2014 Consumer Financial Protection Bureau survey. If you're sick, the stress from taking time off from work and mounting medical bills can increase your problems.
If you feel that you're facing insurmountable medical bills that could affect the rest of your life, it might be time to tap your retirement account early. You'll have to follow a few rules to avoid penalties, however.
Medical expenses offer certain exemptions, but normally, the government imposes a 10 percent tax penalty on money withdrawn before age 59.5 to discourage people from withdrawing early. You still might need to pay taxes on the amount you withdraw. Also be aware if your withdrawal nudges you into a higher tax bracket.
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Negotiate your bills first. Many hospitals and medical companies have sliding scales and payment plans for the disadvantaged that might lower your bills to a manageable amount. Others can trim the bill if you agree to pay it in one lump sum.
Call their medical billing office and try to negotiate your bills before tapping your retirement funds.
Also look for organizations that offer co-pay relief for your type of illness or injury. If the organizations take time to process your payments, many hospitals can stall the collections process if you ask them to, especially if they realize you're trying to pay your bill.
Check if you're entitled to disability payments. "Policies vary, however they will often cover any illness or accident that causes you to be unable to do the duties of your current job or another occupation," says Raymer Malone, financial planner and owner of H.I.P. Insurance Agency.
Some companies, like Aflac (ticker: AFL), can pay out a lump sum for time spent in the hospital.
"The first place to check would be your employer," Malone says.
Some companies offer long-term disability coverage, and short term disability coverage. Five states (California, Hawaii, New Jersey, New York and Rhode Island) require short-term disability benefits that typically cover 26 to 52 weeks, Malone says.
For people who aren't sick, carrying disability insurance is a nice hedge, and could protect your assets when you need them most, says Chantel Bonneau, wealth management advisor and financial planner for Northwestern Mutual.
"Start by building an emergency fund in a savings account that you protect and value and set aside," she says. "Also, evaluate the disability coverage that is provided by your employer, if any, and try to build in extra protection with individual coverage that you can keep long term."
Stay within the year of the expense. Timing is very important if you're asking for a distribution from your retirement plan. Plan ahead so you're not up against the year-end deadline.
"You need to take the distribution the same year as the expense," Megan Gorman, founder of Chequers Financial Management, says. "So if you are considering this year end, consider when the expense will be paid. You do not want to take a distribution in December when the expense will not be paid until the following January."
The way it works is if you are younger than 59.5, the IRS allows a penalty-free distribution from a retirement plan to pay for medical expenses that aren't reimbursed by your health insurance, provided that they exceed 10 percent of your adjusted gross income, Gorman says.
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If you lose your job, you can also pay for health insurance for you and your family from your IRA, penalty free. If you're disabled, and your doctor signs off on it, that's another penalty-free exception.
Consult your CPA and plan administrator. The rules can be complicated, and they vary for accessing money in qualified retirement plans such as 401(k) plans and individual plans, says Heather Wonderly, senior retirement plan consultant, accredited investment fiduciary and certified plan fiduciary advisor.
In most 401(k) and 403(b) plans, employers decide if there will be hardship distributions -- such as in cases of illness -- available to plan participants, says Justin J. Kumar, senior portfolio manager for Arlington Capital Management.
"An ill plan participant can request a distribution under a hardship distribution, but the IRS mandates that all other available distributions and loans are accessed in the plan first in order to avoid triggering an early withdrawal penalty," Kumar says. "It is important to discuss options with the HR department and plan consultant to be aware of the specifics in the plan."
Document carefully. "Don't forget when taking distributions, you need to document, document and document some more," Gorman says.
Check that the provider codes distributions correctly so the IRS doesn't penalize you inadvertently. "If you keep careful records, you will be able to address any incorrect data to protect yourself," she says.
Also, check forms very carefully during the distribution process.
"You want to make sure that you are electing the right distribution," Gorman says. "You shouldn't hesitate to have your CPA review or call the plan custodian to review the forms with you."
Options for traditional IRAs and Roth IRAs. "Tax deductible medical expenses can be withdrawn penalty free," says Abbey F Rollins, financial planner and director of Financial Planning for AKT Wealth Advisors.
But withdrawing from Roth funds may be easier. "As long as a Roth IRA has been open for more than five years, the money you have contributed can be withdrawn without penalty at any age," Rollins says.
However, watch out if your IRA has grown and you're trying to withdraw more than you've deposited.
"If the amount you've earned on the money in that account is withdrawn it is much harder to avoid the 10 percent early withdrawal penalty on that portion," Rollins says. "Individuals should consult with a tax advisor prior to initiating a withdrawal to ensure funds are taken from the most advantageous source."
Consider a loan. A loan from your plan is another option available for tapping into a retirement plan without paying penalties, but you'll have to eventually pay back the money, Gorman says.
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"Most 401k and 403(b) plans may offer the ability to take a loan against the plan," she says. "The participant could take a loan that is $50,000 or the greater of $10,000 or 50 percent of the account balance. The participant would have up to five years to pay the loan back. There are no penalties but if you do not pay the loan back, it defaults and is treated like a distribution -- with penalties."
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