You get $1,000 for an emergency of your choice. It could be a doctor’s bill or groceries.
There is a new, interest-free, penalty-free option if you need a quick $1,000.
The Internal Revenue Service has now made it easier to take a limited amount of money out of a traditional retirement account penalty-free. While previously you could tap your savings without penalty in more limited ways, and often with more paperwork, you can now take out up to $1,000 of your funds for any self-defined emergency.
The change comes after the IRS spelled out what counts as an emergency personal or family expense under a 2022 retirement law that went into effect this year. The reasons can include medical care, funeral expenses and auto repairs, but the key phrase is the catchall “any other necessary emergency personal expenses.”
The $1,000 provision is different from other retirement-account withdrawal options because you can just say that you have an emergency, without specifying what it is. So you can get the money faster. It is one of several ways Congress keeps making it easier for people to use their retirement savings as emergency funds.
When you take money out of a pretax retirement account early, you pay income tax and a 10% penalty, unless an exception applies. Taking out $5,000 for adoption expenses doesn’t incur a penalty, for example. That’s how the new $1,000 emergency expense exception works, too.
You’ll still owe income tax on the $1,000 you take out if you don’t pay it back.
Who it’s for
The new option is mainly meant for low- to moderate-income Americans who can’t spare $1,000 from a checking or savings account, said Catherine Collinson, president of Transamerica Center for Retirement Studies. It’s faster and cheaper than credit cards, personal loans or other ways to tap retirement savings.
“Many workers find themselves in a pinch when they lack emergency savings,” Collinson said. “This provision lets them access fast cash.”
Voya Financial, which has a big retirement-plan business, is surveying workers about the new $1,000 provision. Some say they are more likely to increase retirement savings knowing they can use the account in an emergency, said Tom Armstrong, vice president for customer analytics and insight at Voya.
Emergency withdrawals have been on the rise in recent years as prices for everyday goods increased and credit-card debt grew. A stock-market boom also drove up retirement-account balances and has helped make people more comfortable dipping into their accounts.
The fine print
The new $1,000 emergency-expense provision is optional for employer plans. As of now, not all 401(k) plans have adopted it.
You can make only one emergency withdrawal a year. If your account is small, you can’t take out so much that the balance would then be under $1,000. For example, if you have $1,500 saved, you can take out only $500.
You have only three years from the day after the withdrawal to put the money back—whether into the same account you took it out of, or into another retirement account in your name. But you don’t have to.
You can’t take another emergency withdrawal for the three years after the year you took the money out, unless you repay yourself or make enough new contributions.
There isn’t a penalty for failing to put the money back in.
Withdrawals
Most 401(k)s allow hardship withdrawals under limited circumstances, and you often have to wait for your employer to certify your reason. You also aren’t allowed to put the money back into the account.
Taking a loan from a workplace retirement plan is an option, but loans have downsides too, including the risk of default if you’re laid off.
First-time home buyers can take $10,000 penalty-free out of an individual retirement account to put toward a down payment, but they can’t do the same from a 401(k).
The downside of withdrawals: You’ve robbed yourself of retirement savings. It isn’t a decision to be taken lightly, said Collinson.
Don’t forget taxes
You have to pay income tax on your pretax emergency cash if you don’t put it back.
“A lot of people are so caught up on the ability to get out of the 10% penalty,” said Ian Berger, an IRA analyst in Rockville Centre, N.Y., “that they lose sight of the fact that they’re going to be taxed.”
You claim the exception to the 10% penalty on your tax return.
Source: Wall Street Journal
