It is easier to take up to $1,000 out of retirement plan savings to help with an emergency under a new rule from the Internal Revenue Service. The IRS announcement clarifies a 2022 law that aimed to reduce paperwork, costs and delays when savers tap retirement funds to cover unexpected expenses. Previously, withdrawing retirement funds before retirement generally meant paying penalties as well as income taxes except in a handful of special situations. Now savers can take early withdrawals for any need they consider urgent without owing penalties. Withdrawals are limited to $1,000 per year and have to be repaid within three years or income taxes are due. A financial advisor can help you evaluate options for covering unexpected expenses.

Emergency Funds from Retirement Accounts

When the Secure 2.0 Act was passed in 2022, it contained a provision expanding savers’ ability to use tax-deferred retirement accounts including IRAs and 401(k) plans as general-purpose emergency funds without incurring penalties. Previous rules allowed penalty-free early withdrawals before age 59 ½ only in a limited number of circumstances, such as needing a down payment to buy their first home in some cases.

Until the IRS issued its new rule in July 2024, however, nothing really changed. Retirement savers could only take early withdrawals from retirement funds if they paid penalties and taxes, qualified for one of the hardship exemptions or took loans from 401(k) plans, all of which typically involved significant cost, delay or both, compared to the solution set up in Secure 2.0.

Under the new rule, savers can take up to $1,000 from a retirement plan once a year. Rather than having to show that they meet a special situation, they can state they are using funds for everyday emergencies such as car repairs or medical bills. Or they can simply say funds are needed for unspecified emergency personal expenses.

They can withdraw the funds without owing penalties, even if the withdrawal occurs before age 59 1/2. The withdrawals aren’t treated as loans, like a loan from a 401(k) account would be. However, if the money is replaced in the account within three years, no taxes are due either.

Only one emergency withdrawal of up to $1,000 can be made per year. The account balance has to be at least $1,000 after the withdrawal, so on smaller accounts a lower cap would apply to the withdrawal in order to keep the remaining account balance at $1,000.

Usually, taking money out of your retirement account should be a last resort. Consult a financial advisor for professional advice about ways to make your assets work for you.

Pros and Cons

Having a rainy-day fund of three to six months of expenses where it is safe and readily available is still the most effective way to be prepared for emergencies. And there are other ways to use retirement funds for emergencies. For instance, if someone saves for retirement using a Roth account, contributions can be withdrawn at any time for any reason without owing penalties or taxes.

Compared to existing options, the new emergency withdrawal rule provides savers facing unexpected expenses with a potentially useful new possibility. It does have limitations and potential drawbacks, including:

Pros

  • Less costly than using credit card or personal loan to cover unexpected expenses.
  • Applies to a wider range of needs than previously available exemptions for early withdrawals
  • Funds are available sooner than when borrowing from a 401(k) and money doesn’t have to be repaid.
  • May encourage people to save more for retirement knowing they can tap it in an emergency.

Cons

  • Money has to be returned to the account in three years or income tax is owed.
  • Amount is limited to $1,000 and can only be taken once per year.
  • Not all workplaces have savings plans and not all that do offer this emergency withdrawal feature.

Bottom Line

Final IRS rules on a feature of the Secure 2.0 Act, make it possible for people under age 59 ½ with tax-deferred retirement accounts to take up to $1,000 per year from the plans without owing penalties. Withdrawals can be taken to fund any need the saver considers an emergency, without having to meet previously strict eligibility requirements. If paid back into the account within three years, the money isn’t subject to income taxes either.

Tips

  • Covering unexpected expenses such as medical bills can be costly if you are relying on high-interest credit cards or personal loans. A financial advisor can help you start an emergency fund to make it easier to deal with these sorts of problems. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Get a glimpse of how much your 401(k) account could be worth one day using SmartAsset’s 401(k) Calculator.
  • Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.

Photo credit: ©iStock.com/Brankospejs

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