Emergency Withdrawals from Retirement Accounts

Making an “early” withdrawal from a retirement account is typically a costly decision, as the government tacks on a 10% penalty for early withdrawals made from traditional IRAs and 401(k)s before the account owner is age 59 ½. That’s in addition to the income tax due on withdrawals from traditional retirement accounts. (Note, if you leave a job and are at least 55 you can make withdrawals from your 401(k) without being hit with the 10% early withdrawal penalty. That said, I am not endorsing tapping retirement savings at such a young age.)

Federal rules now have made it less costly to take a modest early withdrawal for any emergency, without having to pay the 10% early withdrawal penalty.

Before I get into the nitty gritty of the new rules, I want to be on the record that it is my sincere hope that you never need to touch your IRA or 401(k) savings before you are retired. I realize life happens, creating unanticipated costs, or periods where your income is lower. Understood. But that is why I am such a (loving) nag about building up an emergency savings fund. The new rules limit penalty-free withdrawals to $1,000 a year. I want you to eventually have far more than $1,000 in your emergency savings fund, but if you’ve yet to get started, I think $1,000 is a terrific savings goal to set for yourself. Once you have the $1,000 in your savings account, you won’t need to tap your retirement savings if an emergency expense does arise. And leaving your money growing in your retirement accounts should always be your goal.

Okay, but as I said, life can sometimes be messy. So let’s walk the rules on how this works:

• You can withdraw $1,000 a year. Regardless of your age you will not owe a 10% early withdrawal penalty fee.
• You owe income tax on your withdrawal from a traditional retirement account. All withdrawals from traditional accounts are subject to income tax. The only change is that the new regulation waives the 10% penalty fee for a qualifying early withdrawal.
• It’s not hard to qualify. You will need to submit written notice that the withdrawal is indeed for an emergency, but the IRS has just clarified that it has a very broad definition of what qualifies as an emergency. You can with withdraw up to $1,000 “for purposes of meeting unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.”
• You are expected to repay the money into your retirement account within three years. If you don’t repay the money (or make new contributions that are at least equal to the amount you withdrew) you will not be permitted to make additional annual $1,000 penalty-free withdrawals.
• The balance must remain above $1,000. Your $1,000 annual limit assumes you will still have at least $1,000 remaining in the retirement account.

Again, it is my hope that every household can build their own personal emergency savings fund so they never have to tap retirement savings for a small/moderate emergency expense.

But I also want you to rest a little easier, that if you do find yourself in a financial bind, you may be able to borrow money from your own retirement account, without a costly 10% early withdrawal penalty.