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More Options for Early IRA, 401(k) Withdrawals

New federal law adds exceptions to tax penalty for hardship distributions from retirement plans

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When we put money into a retirement account, we generally have every intention of leaving it there to grow until we retire. But life happens. Maybe you or a loved one loses a job, suffers a serious illness or experiences a sudden financial setback, and you find yourself needing those funds.

But taking money out of a 401(k) plan or individual retirement account (IRA) early — defined by federal law as before age 59½ — carries a cost. Not only are you on the hook for federal and state income taxes on what you withdraw, but you typically must pay a 10 percent penalty on top of that.

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If you’ve experienced a financially devastating event, you may have no other choice, says Cynthia Pruemm, founder and chief executive officer of SIS Financial Group in Hoffman Estates, Illinois. “You've got to take that hardship [withdrawal] to get your life back in order.”

There are select circumstances in which the IRS may waive the early-withdrawal penalty, among them “hardship distributions” to meet an immediate, heavy financial need or withdrawals to cover higher education, funeral expenses or a first-time home purchase. The list is growing, thanks to SECURE 2.0, the wide-ranging retirement savings law enacted in late 2022.

Easier access for emergencies 

SECURE 2.0 ushers in dozens of changes to federal rules governing retirement plans, including several that remove penalties and other hurdles to accessing those funds in an emergency.

For example, starting in 2024, you may be able to pull up to $1,000 from a retirement account, without owing the 10 percent penalty, for “unforeseeable or immediate” needs arising from a personal or family emergency. You are restricted to one such distribution every three years unless you opt to treat it as a loan and pay it back within that period. 

SECURE 2.0 also lays out several new scenarios where you can pull money from your 401(k) or IRA without having to pay the 10 percent penalty.

  • Disasters: In the event of a federally declared disaster, you can take up to $22,000 from a retirement plan to cover such costs as rebuilding a house or replacing a car (effective for disasters going back to Jan. 26, 2021). 
  • Terminal illness: People diagnosed with a terminal medical condition can make penalty-free withdrawals if they are expected to die within seven years (in effect now).
  • Domestic abuse: Survivors of domestic abuse can withdraw up to $10,000 or 50 percent of the account balance, whichever is less, potentially providing money to escape an abuser (takes effect Dec. 31). 
  •  Long-term care insurance: Starting Dec. 29, 2025, the penalty can be waived for distributions of up to $2,500 per year to pay premiums for long-term care (LTC) insurance that provides “high quality coverage.” According to the American Association for Long-Term Care Insurance, that likely means traditional, stand-alone LTC policies but could also include some of the more popular “hybrid” policies that combine LTC and life insurance, depending on their features.

SECURE 2.0 also allows people with 403(b) plans to access more of their retirement funds for hardship distributions. To date, only an employee’s contributions to a 403(b) — a 401(k)-like plan typically offered by nonprofits and educational institutions — are available for such withdrawals. But beginning in 2024, 403(b) participants can tap investment earnings on the account as well as the money they put in themselves, as 401(k) holders can do.

If you do need to make a withdrawal, SECURE 2.0 also makes it easier for you to make your case. When you go to your retirement plan administrator to request a hardship distribution, you can “self-certify,” meaning the administrator can take your word for it that there is a qualifying hardship and that you have no other funds available to address it. 

Talk to your plan administrator about the specific rules of your plan, Pruemm advises. They will be able to tell you if you qualify for a penalty-free withdrawal or can take advantage of other workplace saving opportunities. Whatever you decide to do, she adds, “what's great is that SECURE 2.0 offers a lot more options.”

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An incentive to save?

While the changes make it easier for people to take withdrawals from their retirement accounts, they may also encourage them to save more, notes Dan Doonan, executive director of the National Institute on Retirement Security.

Someone with little savings may be hesitant to stash money in a retirement account because it means locking the money up for a long time, he says. “Having some outs [in case of emergency] might make them more comfortable saving," Doonan says.

Financial experts regularly recommend having at least three to six months of living expenses readily available in case of emergency, but many Americans can’t afford that kind of a cushion. A 2022 Federal Reserve report found that nearly one in three would have trouble covering an unexpected $400 expense. 

Inflation, which reached a 40-year high last year, has compounded the problem. According to Vanguard, 2.8 percent of retirement plan participants took out a hardship withdrawal in 2022, up from 2.1 percent the year before. 

While SECURE 2.0 makes such withdrawals less painful in certain situations, it also aims to help people avoid having to take them by providing new pathways to build rainy-day savings. Employers that offer retirement plans can now also automatically enroll most workers in emergency savings accounts. 

Up to 3 percent of the employee’s after-tax wages would go into the emergency account; when the balance reaches $2,500, additional contributions can be directed into the worker’s retirement plan. 

While employees can opt out of the emergency plan, “any option that's out there that can help you save and impede drawing on retirement funds prior to retirement is a great resource,” says Dan Simon, a retirement planning adviser at Daniel A. White & Associates in Middletown, Delaware. 

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“If an employer is offering some type of savings vehicle emergency-type fund, I would certainly encourage people to take advantage of it,” he says.

Weigh the costs of a withdrawal

Though it’s getting easier to make penalty-free withdrawals from a retirement account, choosing to do so should not be taken lightly. People are living longer, Simon notes, and “drawing down on retirement assets sooner rather than later impacts the sustainability of withdrawals from those accounts and how long those accounts will provide income.”

He advises clients to withdraw from retirement accounts only as a last resort. The longer the money stays put, the more it earns in interest and investment returns. “If you're late to the game on retirement, it's very hard to catch up,” he says.

Every situation is different, and there’s no one-size-fits-all answer to whether or when to take an early distribution. But these guidelines may help you determine if a withdrawal makes sense for you.

Keep the tax implications in mind. Speak to a tax professional before making a withdrawal. Even if you don’t have to pay a 10 percent penalty, you must still pay income taxes on the money, and the distribution could put you in a higher tax bracket, leaving you with a bigger tax bill, Simon says.

Consider borrowing instead. You may be able to borrow from your workplace plan — up to $50,000 or 50 percent of the account balance, whichever is less. You’ll have to pay it back with interest in a set time, typically five years, but you won’t owe taxes on the money. However, if you leave your employer before repaying, you may have to pony up the remaining loan balance immediately or it will be treated — and taxed — as a distribution.  

Earlier is better (for your nest egg). Any money you withdraw from a retirement account is a potential drag on its future growth. The more time you have before retirement, the longer you’ll have to replenish it. “If you have a couple more decades to work, you have a lot more time to make up for market losses than somebody that's 62 or 65,” Pruemm says.

Seek alternative ways to access cash. Getting a temporary part-time job or asking family members for help could be a better option for managing a short-term cash crunch. “Try to create a little bit more income so you're not depleting what you just spent the last 20, 30, 40 years accumulating to take you to the finish line,” Simon says.

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