Making an early withdrawal from your retirement account can be complicated. As consumer confidence falters and government layoffs dominate the news, it’s smart to consider your options if you need additional cash. According to the Federal Reserve, many Americans don’t have three months of emergency savings.
There are indications that more people are having problems paying their bills today than when the Fed did its survey more than a year ago. One source is that Americans consider tapping their retirement accounts in an emergency or when they’re short of cash. For many workers, retirement accounts represent most of their liquid savings.
At the end of 2024, $15.2 trillion was held in individual retirement accounts (IRAs) and another $12.4 trillion in workplace-defined contribution plans such as 401(k), 403(b), and 457 plans, according to the Investment Company Institute. Generally, a retirement plan can begin distributing money after a participant reaches a certain age—usually 59-1/2. If you take funds earlier, you usually must pay a 10% penalty in addition to normal federal income tax on the distribution.
The rules on early withdrawals are complicated and seem to be constantly changing.
Here’s an up-to-date briefing on what you need to know. A hardship distribution is a pre-retirement withdrawal from your 401(k) plan, 403(b) plan, or 457(b) plan due to an immediate and heavy financial need.
The withdrawal amount is limited to the amount needed to satisfy that financial need and is generally subject to the 10% early withdrawal penalty. There is no bright-line definition for hardship—it’s determined by the employer under the retirement plan terms and based on facts and circumstances. However, certain expenses qualify under IRS “safe harbor” rules, such as medical expenses, costs associated with purchasing a principal residence, payments to prevent eviction or foreclosure, repairs for damages to a principal residence, tuition, and room and board costs for the upcoming 12 months of postsecondary education, and funeral expenses.
A hardship distribution must be limited to the amount needed to meet the need.
Hardship withdrawals and tax implications
Not all funds in the plan are available for withdrawal.
Hardship distributions are generally allowed only from accumulated elective deferrals, employer nonelective contributions, and standard matching contributions. They aren’t tax-free; they are subject to federal income taxes unless they are from Roth accounts.
As part of the SECURE 2.0 Act, you can now make $1,000 penalty-free withdrawals for emergency personal expenses if your retirement plan allows it. Distributions are still subject to ordinary taxes. Emergency personal expense distributions are withdrawals made to address unforeseen or immediate financial needs.
There are three limitations: you cannot treat more than one distribution per calendar year as an emergency personal expense, the withdrawal limit is $1,000 or your non-forfeitable accrued benefit under the plan minus $1,000, whichever amount is less, and if you request an emergency distribution, you cannot do so again during the next three years unless the previous distribution is repaid or elective deferrals and contributions equal the unpaid previous distribution. Examples include medical care, accidents or property loss due to unforeseen circumstances, imminent foreclosure or eviction, burial or funeral expenses, or essential auto repairs. The SECURE 2.0 Act also introduced a provision for domestic abuse victims, allowing them to withdraw up to $10,000 or 50% of the current value of the plan’s non-forfeitable accrued benefit, whichever is lower, without penalty.
The distribution must be made within one year of the date on which the individual is a victim of domestic abuse by a spouse or domestic partner. Domestic abuse includes physical, psychological, sexual, emotional, or economic abuse. The repayment rules are the same as those for repaying qualified birth or adoption distributions.
You can repay a domestic violence distribution at any time within three years starting the day after the distribution was received. Making an early withdrawal from your retirement account should not be taken lightly. Understanding the rules and the potential penalties can help you make a more informed decision during tough financial times.
