Feature Articles
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Life-threatening Illness
and Your Retirement Accounts
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If you become seriously ill at a young age, you may
wonder what good your 401(k) savings are, since they are earmarked for a retirement that
may never happen. What's more, if you're under 59ý your access to this money is
restricted just when you may need it the most.
In fact, there are ways to get at your 401(k)
money if you need it. Or, if you have enough liquidity without it, you may want to
continue contributing for the tax break and for the eventual benefit of your spouse or
other loved ones.
When you plan for retirement, the idea is to take a
long-term perspective. You build your money up over time so that one day, when you've
worked long and hard, you can afford to retire and live off the fruits of your labor.
That scenario changes drastically with the diagnosis of a
life-threatening illness. Suddenly, you need to plan for the short term as the possibility
of retirement evaporates. "A lot of things you normally advise a client to do will
flip-flop if they become terminally ill," said Ron Pearson, a certified financial
planner in Virginia Beach, Va.
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"A lot of things you normally
advise a client to do will flip-flop if they become terminally ill."
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| —Ron Pearson,
certified financial planner in Virginia Beach, Va. |
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If you are diagnosed with a serious illness, you may not
want to spend time thinking about money. But, it is important to manage your finances so
you can live the rest of your life as comfortably as possible. You also want to leave your
affairs in order for your loved ones.
If you have a 401(k) or other retirement accounts, you may
not be sure how to access that money, which is normally off limits until retirement age.
There are ways to get to the money, and what you choose to do could affect your
beneficiaries. If your financial situation is complex, you should seek advice from an
experienced professional.
Liquidity Becomes Paramount
When a person is diagnosed with a disease that will require
extensive treatment and could cut life short, liquidity becomes paramount, says Pearson.
The standard rule of having 3–6 months of emergency cash reserves no longer applies.
How much do you need? "As much as possible," said
Pearson. He noted that the amount would depend on factors such as whether you have medical
insurance, and how extensive your coverage is.
Your 401(k) plan may not be an immediate source of
liquidity, depending on your circumstances. As long as you are working, if you are under
59ý years old you generally won't be able to withdraw money from your 401(k) unless you
qualify for a hardship withdrawal. This would generally allow you access to your money to
pay high medical bills, or if you became disabled. Not all plans permit hardship
withdrawals though, so you should ask your benefits administrator what the rules are for
your specific plan. Also, you would have to pay taxes and possibly a 10 percent penalty on
the money you withdrew.
If your plan allowed loans, you could investigate the
possibility of borrowing from your 401(k) plan.
If you quit your job and are at least 55 years old, you
could withdraw your 401(k) money in a lump sum. You would owe tax, but not the 10 percent
early withdrawal penalty.
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You may decide to stop contributing to a 401(k) and invest
in something more liquid, like CDs, short-term bonds, and money markets. "Just like
anyone else, money you're going to need in the next five years you don't want in the stock
market," said Pearson.
If you have good medical insurance and considerable assets
outside of your 401(k), however, you might decide to continue making 401(k) contributions.
This would give you a tax benefit, and could provide a source of retirement income for
your spouse. "It's an independent, individual solution," he added.
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| Read More: |
| For more about 401(k) hardship withdrawals
and loans, look in the "distributions" section of our Frequently Asked Questions |
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One Woman's Story
Consider 31-year-old Michele Murphy. Diagnosed with
Acquired Immune Deficiency Syndrome seven years ago, she has saved about $20,000 in a
403(b) plan with a previous employer, and is planning to contribute to her new employer's
401(k) plan. Still, she admits to being "nervous" about investments that
restrict access to the money before retirement.
"Although there is currently a more promising outlook
for those of us living with AIDS than there was when I tested positive, there is
absolutely no guarantee that I'll make it to 59ý," she said.
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"...There is absolutely no
guarantee that I'll make it to 59ý."
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| —Michele Murphy,
31, who has AIDS. |
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Despite that, she saves for retirement in part because it
helps her remain optimistic. "If you have things to look forward to — and the
means to afford them! — it makes it that much easier to take care of yourself, to
enjoy what you have," she added.
"It's really an individual situation. If you are in a
place where you have enough income to put some aside for the future, then you really
should," she said.
Help Your Beneficiaries
When a terminally ill person comes to Dan Moisand, a
certified financial planner, for advice, "first and foremost, we ask about the
beneficiary issue," he said. Some people haven't updated their beneficiaries in
years, perhaps since they were married, had children, or found a new life partner. Or,
they may not have ever named a beneficiary, in which case the 401(k) may automatically go
to the estate and be subject to the lengthy probate process.
Spouses who inherit a 401(k) may be able to treat it as
their own, that is, continue to make deferrals into it, or roll it into an IRA, preserving
the tax advantage. Beneficiaries who are not spouses have more limited options.
Moisand, of Melbourne, Fla., gives the following example.
Say you want to leave your 401(k) in equal parts to your three children. If you list
several beneficiaries on your 401(k), they will be required to take a lump-sum withdrawal
and pay tax on the entire amount at once, before splitting it three ways, said Moisand.
They will not be able to withdraw the money in small annual increments, as a single
beneficiary might be able to do.
Moisand said he would advise a client in this situation to
roll the 401(k) into three separate IRAs, designating one child as the beneficiary on each
account. Remember though, even if you are ill, you can only roll over your 401(k) once you
leave your job.
Lower Investment Risk
If a diagnosis shortens your time horizon, you need to
bring your investments in sync with your new situation. If you may need to take a hardship
withdrawal from your 401(k) in a few years, move some of the money you have in high-risk
funds into lower-risk funds.
"If a client has 80 percent of his investments in
stock funds and no medical insurance, the time frame and the asset allocation don't match
up any more," said Moisand.
Credit Is Your Friend
Credit may become your lifeline if you are seriously ill,
said Pearson. "That's another thing that flip-flops. Suddenly you don't want to throw
away your credit cards — you may need them."
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"Suddenly you don't want to throw
away your credit cards — you may need them."
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| —Ron Pearson,
certified financial planner in Virginia Beach, Va. |
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Pearson sometimes suggests that his terminally ill clients
look into "credit life insurance," which takes care of unpaid credit balances if
the insured person dies. But, don't consider it if you're not seriously ill, he warns,
because it can be "a rip-off."
Embrace Your Opportunity
As difficult as it is for many people to accept the
certainty that they will die, Moisand said he encourages his clients to take the time to
put their affairs in order for their loved ones. Not everyone has that opportunity.
"If you drop dead of a heart attack one day, you won't
know what kind of chaos you might have left behind," he said.
"Sometimes people go into a sort of denial, like as
long as they don't plan for a funeral, the funeral will never come," said Moisand.
"That's understandable, but it's not smart."
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"If you drop dead of a heart
attack one day, you won't know what kind of chaos you might have left behind."
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| —Dan Moisand,
certified financial planner. |
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"I ask people how they want to be remembered, and of
course they never say they want everyone to complain or curse them for what they didn't
do," he said. "I had one client who viewed his estate plan as his final love
letter to his family."
With advances in medical treatment, some people are living
longer with serious illnesses, and even overcoming them.
"I have one client, a cancer survivor, who focused a
lot on 'the end'. When 'the end' didn't come, it totally changed her life. Everything she
does now emanates appreciation for having that day," said Moisand.
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
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