Accessing Your 401(k) for Emergencies Is Easier Than Ever

It’s now easier to withdraw from your retirement account in an emergency, but that doesn’t mean you should.

According to the SECURE 2.0 legislation and a recent decision issued by the IRS, you can withdraw 1,000 year from your retirement account once a year in matter of an emergency – defined as “covering unpredictable or immediate financial needs related to necessary personal or family emergency expenses.”

While this gives people more ways to deal with emergencies, it is not an option they should take lightly.

“It’s nice to have the flexibility, more options, but that doesn’t mean you should. In general, pension funds are designed for retirement,” said Rob Williams, general manager of financial planning at Charles Schwab.

“Do not touch pension funds in an emergency. It’s almost okay to say that money is inviolable. It’s for your future self,” Williams said. “Of course we have emergencies and we have emotions. But the more you think that this money is intended for a specific purpose, the better you will be in the long run.”

Troy Owens, a certified financial planner at AlphaCore Wealth Advisory, agreed.

“It’s always the option of last resort,” Owens said. “When you withdraw money from your retirement accounts, you withdraw significantly.”

Until now, the only way to run your retirement accounts was to make an early withdrawal and pay penalties and taxes.qualify for a hardship withdrawal for a serious emergency such as an eviction notice or committal expenses; or take out a loan from a retirement account. The new legislation makes it easier to raise funds, but there are safeguards for the allowable amount.

The new rules are in small print: You can’t let your total retirement balance fall below. You have three years to return the money to a retirement account, or you pay income taxes on the withdrawal. You can withdraw more money only after you have repaid the previous withdrawal. In addition, your employer’s pension plan must allow for emergency withdrawals.

Not all pension plans may offer this option yet.

“It’s still relatively new, so most employers are still considering whether to add this feature to their retirement plans and how they will add it,” said Cassandra Rupp, senior wealth management advisor at Vanguard.

But if you’re not using your 401(k) for emergency funds, where do you get the money to handle an emergency? Consider this: more than a third of U.S. matures might not cover a hypothetical emergency spending of using cash or an equivalent amount, such as by using a credit card that they would pay back in full the following month, according to the 2022 U.S. Household Economic Well-being report released by the Federal Reserve.

Owens said other options for emergencies might be better, such as taking funds from a Roth IRA, where you can withdraw contributions paid to a Roth with impunity and tax-free. (However, profits from these contributions are subject to restrictions.) Also consider a 401(k) loan instead of a payout, he said.

Of course, not everyone believes that it’s such a bad idea to tap into a retirement account when life’s problems arise.

“Since people are feeling the inflation and the costs remain high, this is certainly a unique opportunity. It is the IRS that is opening up more avenues,” Ronnie Thompson, financial advisor and owner of True North Advisors.

“What is the alternative? With a credit card or a loan, interest rates are astronomically high and you could end up spending hundreds of dollars on interest,” Thompson said. The 1,000-from hit of your Pension Fund is not a huge number that will affect your future financial health.”