When death strikes and the deceased was unprepared financially, survivors face the added burden of paying for the arrangements. That burden can average more than $6,500 beyond buying a cemetery plot, grave marker, obituary and flowers, according to a 2010 study by the National Funeral Directors Association. Individuals and beneficiaries can use retirement savings to pay funeral expenses. Depending on their plan, they may avoid paying a penalty to do so.
Traditional IRA and Roth IRA
The IRS permits traditional IRA withdrawals, but imposes a 10 percent early withdrawal penalty. However, a beneficiary needing to pay funeral expenses can receive a decedent's IRA funds penalty-free. The amount withdrawn in both cases is reported as ordinary income, and is subject to federal and state income tax. Borrowing from an IRA to pay for a funeral is not an option. The owner of a Roth IRA can withdraw money he contributed tax-free at any time; however, withdrawals of earnings from those contributions become taxable and trigger a 10 percent penalty when made prior to five years of participation. As with traditional IRAs, a Roth IRA heir pays no penalty when the owner dies before age 59 1/2.
401(k) Hardship Withdrawal
Employers may offer plan provisions for distributions and loans, although they have no obligation to do so. The Internal Revenue Service classifies funeral and related expenses as an "unforeseeable emergency" that puts an employee into a situation of "immediate and heavy financial need." A hardship withdrawal must meet this definition of need. Any hardship distribution permitted by the plan for funeral expenses of the employee's spouse, dependents, children or the employee himself must be limited to the actual costs plus any taxes incurred as a result. Employers may request verification to comply with IRS regulations. Hardship distributions permanently reduce a 401(k)'s value because they cannot be repaid.
Under IRS rules, an employee who needs to access a 401(k) for a hardship withdrawal must first borrow from his plan. A loan incurs no tax or penalties, but must be repaid within five years. And, unlike the six-month savings moratorium a hardship withdrawal imposes, a 401(k) loan does not prohibit the employee from continuing to make contributions. In the event the borrower leaves the company for another job, the unpaid loan balance is recorded as income subject to both income tax and early withdrawal penalty. If the employee has exhausted his borrowing ability, a hardship withdrawal for funeral expenses can be made penalty-free. However, the funds withdrawn become taxable as ordinary income because they were originally contributed on a pre-tax basis.
Participants in 403(b) and 457(b) plans can withdraw money like 401(k) participants. However, unlike 401(k) and 403(b) withdrawers, those pulling money from a 457(b) face no early distribution penalty regardless of their age. The IRS definition of hardship for 401(k)s applies to 403(b) and 457(b) plans, allowing for penalty-free withdrawals. These plans also limit the amount withdrawn for funeral expenses to cost plus distribution-related taxes and usually require participants to exhaust their borrowing options first. Note that the IRS holds designated Roth IRAs -- Roth IRAs existing through employer 401(k), 403(b) and 457(b) plans -- to the same pre-tax withdrawal restrictions and hardship eligibility as the plans under which they fall.
- National Funeral Directors Association: Statistics
- Internal Revenue Service: Retirement Topics - Hardship Distributions
- Bankratecom: Penalty-free 401(k), IRA Withdrawals
- Internal Revenue Service: Publication 590 Individual Retirement Arrangements (IRAs)
- Internal Revenue Service: Retirement Plans FAQs Regarding Hardship Distributions
- Internal Revenue Service: Do’s and Don’ts of Hardship Distributions
- 401k Help Center: 401K Plan Loans – An Overview
- Internal Revenue Service: Retirement Plans FAQs Regarding 403(b) Tax-Sheltered Annuity Plans
- Edward Jones: 457(b) Plans
- Internal Revenue Service: Designated Roth Accounts Under 401(k), 403(b) or Governmental 457(b) Plans: