Laura reviews the rules for taking retirement account withdrawals and a new rule for tapping them in an emergency.
Laura reviews the rules for taking retirement account withdrawals and a new rule for tapping them in an emergency.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
Have a money question? Send an email to money@quickanddirtytips.com or leave a voicemail at 302-365-0308.
Find Money Girl on Facebook and Twitter, or subscribe to the newsletter for more personal finance tips.
Money Girl is a part of Quick and Dirty Tips.
Links:
https://www.quickanddirtytips.com/
https://www.quickanddirtytips.com/money-girl-newsletter
https://www.facebook.com/MoneyGirlQDT
https://twitter.com/LauraAdams
You may have considered tapping your retirement savings if you got caught without enough cash to cover an unexpected expense. While the IRS doesn't make it convenient or cheap to use a retirement account like a piggy bank, they have made small changes that help if you're in a pinch.
This post will review retirement account withdrawal rules and a recent change that makes tapping your retirement savings for emergencies less costly. And I'll discuss whether taking advantage of the new rule is a good idea.
Welcome back! I appreciate you joining me for Money Girl episode 887! I'm Laura Adams, an award-winning author, female finance spokesperson, money speaker, founder of The Money Stack, a Substack newsletter, and host of Money Girl with over 43 million downloads.
If you're getting value from the free content we love creating, subscribe and consider submitting a 5-star rating or review on your podcast app of choice! If you have a question about money for the show, leave it on our voicemail at 302-364-0308. You can also send an email and sign up for the free Money Stack newsletter at LauraDAdams.com.
What are the workplace retirement withdrawal rules?
Before discussing the new emergency withdrawal rule that started in 2024, let's review the general rules for tapping a workplace retirement account.
When you have funds in a tax-advantaged, employer-sponsored retirement plan, like a 401(k), 403(b), or 457(b), you must follow strict IRS regulations. The rules were designed to prevent you from taking money out of a retirement account so it stays invested and grows, giving you as much future financial security as possible.
In addition, your employer customizes specific retirement plan options, like who qualifies to participate and whether loans and hardship withdrawals will be allowed. Therefore, if your retirement plan at work allows it, you can take hardship withdrawals.
However, you must pay income tax on amounts not previously taxed, such as deductible contributions and growth in a traditional 401(k). Plus, if you're under age 59.5, you also must pay a 10% early withdrawal penalty on hardship withdrawals, unless you qualify for an exception, which I'll cover in a moment.
However, the catch with hardship withdrawals is that the IRS narrowly defines them. For example, they only list a few reasons, like buying or repairing a primary residence or paying education, medical, or funeral expenses. They say a hardship withdrawal must be for an immediate financial need and can't exceed the necessary amount.
For instance, you can't withdraw $15,000 from your 401(k) for a home downpayment but decide to use a portion for a vacation or car. However, you can use a hardship withdrawal for you, a spouse, or a dependent. In other words, you can take a hardship withdrawal to pay for a child's education or a spouse's unreimbursed medical bills.
But if you have other funds available to pay for a hardship, you're technically not allowed to make a hardship withdrawal. Some plans may specify that you must first take a retirement plan loan to pay for a hardship before requesting a hardship distribution.
Workplace retirement plans allow an employer to rely on an employee's word. For instance, if a worker says they have an immediate need to pay funeral expenses with no other options than their retirement account, then the employer can approve a hardship distribution.
Employers used to be able to prohibit plan participants from contributing to their retirement accounts for at least six months after receiving a hardship withdrawal. But that's no longer the case. Employers can't suspend you from making retirement contributions after taking a hardship withdrawal.
RELATED: 7 savings and retirement rule changes for 2025
What are the exceptions to the 10% penalty?
I mentioned that if you take a hardship withdrawal before age 59.5 from a workplace retirement plan, it is taxable and will be subject to an additional 10% early withdrawal penalty.
However, the following are some exceptions when you can take a retirement withdrawal and skip the 10% penalty.
If you take a hardship withdrawal from a workplace plan for other reasons, like buying a home or paying funeral expenses, you must pay taxes plus the 10% penalty when younger than 59.5. In addition, depending on where you live, your state may also tax retirement distributions.
READ ALSO: How should I invest for retirement after a 401(k)?
What are the individual retirement account (IRA) withdrawal rules?
With an IRA, there are no hardship distributions. That's because you can tap your account any time you like, although you may have to pay income taxes plus a 10% early withdrawal penalty if you're under 59.5.
However, certain IRA distributions used for specific purposes are exempt from the 10% penalty, regardless of age. The following allows you to take an IRA withdrawal and skip the 10% penalty.
To learn more, see the IRS chart of penalty exemptions on early distributions.
RELATED: How do wealthy people invest money?
What is the new emergency retirement withdrawal rule?
As I've explained, many common emergencies, like needing a car repair or a plane ticket to visit family, didn't qualify as an IRS-approved hardship. However, a new emergency expense rule went into effect in January 2024 that allows you to take one distribution per calendar year for personal expenses up to the lesser of $1,000 or your vested account balance over $1,000.
You can take an emergency withdrawal from a workplace retirement plan or an IRA and avoid the 10% penalty if you're under 59.5. However, you will owe taxes on any amounts not previously taxed.
While it's a relatively small amount, the new emergency withdrawal could help someone with no savings and desperately needs to tap their 401(k) or IRA. However, once you take an emergency withdrawal, you can't take another one for three years unless you repay it or make new contributions to cover it.
There's some good news if you repay an emergency withdrawal to your retirement account: the IRS treats it like a loan, and you avoid paying income taxes.
However, the downside of tapping a retirement account is interrupting its growth and compounding, which minimizes your future returns. Spending your retirement reduces your balance and your earning power.
For those reasons, never take a retirement withdrawal unless it's your last resort. It's better to consider other options–like making a creditor wait or setting up a payment plan for a medical or funeral bill–than to crack open your retirement nest egg. But life brings unexpected expenses, and the new emergency rule gives you more options in a cash crunch.
If you have a workplace plan that allows it, taking a retirement loan could be a less expensive option because they're tax-free if you repay them on time. The best solution for avoiding financial hardship in the first place is slowly building an emergency fund that you can easily tap for unexpected expenses.
READ ALSO: Am I saving enough for retirement?
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
Money Girl is a Quick and Dirty Tips podcast, and I want to thank our fantastic team!
Steve Riekeberg audio-engineers the show. Brannan Goetschius is our director of podcasts, Holly Hutchings is our digital operations specialist, Morgan Christianson is our advertising operations specialist, Davina Tomlin is our marketing and publicity associate, and Nathaniel Hoopes is our marketing contractor.