If you've had to use your retirement savings for an immediate financial need, you are not alone. Data show more people are tapping into their 401(k)s and IRAs to handle financial emergencies. For instance, the Vanguard Group reported that early withdrawals from retirement accounts reached an all-time high of 3.6% last year, up from 2.8% the previous year, based on about 5 million accounts.
An early withdrawal is typically subject to ordinary income tax and a tax penalty. However, there is some good news: as of January 1 this year, changes to the retirement plan withdrawal rules have taken effect. The SECURE 2.0 Act allows penalty-free withdrawals to address personal emergencies and domestic violence.
Here’s more of what you need to know about how your emergency retirement account withdrawal might impact your tax return.
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IRS rules on 401(k) early withdrawals
Of course, you can withdraw money from your retirement account. However, for those under age 59½, early withdrawals are generally subject to regular federal income tax and a 10% additional tax penalty. That has made them less attractive options for many facing an unexpected financial crisis.
However, as of 2024, a new provision allows individuals to make penalty-free annual withdrawals to cover personal emergency expenses.
- Specifically, you can withdraw up to $1,000 from your qualified plan (e.g., 401(k), 403(b), 457(b)) or IRA (including SEP, Simple IRA) once each calendar year without penalty.
- You will still have to pay ordinary income taxes on the withdrawal.
- However, if you choose not to repay the distribution within three years, you generally cannot take another personal expense distribution during that period.
You only need to self-certify in writing to your employer that the withdrawal is necessary due to an emergency.
What’s an emergency expense? The IRS recently clarified that an emergency personal expense distribution is “made from an applicable eligible retirement plan to meet unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.”
While many emergency or personal expenses can be covered with a personal expense distribution, the IRS provides some general examples. These examples include medical expenses, financial needs related to car repairs, foreclosure, an accident, or a funeral or burial.
It’s good to seek guidance from a trusted tax professional if you are uncertain about taking a personal expense distribution or your plan doesn’t participate.
Domestic abuse distributions SECURE 2.0
Revised retirement account withdrawal rules also offer tax relief to victims of domestic abuse who find themselves in need of financial assistance.
- If you are under the age of 59½ and have been a victim of domestic abuse you can currently withdraw up to $10,000 from a qualified retirement account (or 50% of your vested account balance, whichever is less) without incurring the usual 10% tax penalty.
- However, you generally still pay ordinary income taxes on the withdrawal.
- This domestic abuse victim distribution can be taken within a year following a domestic abuse incident (any date a person has been the victim of domestic abuse by a spouse or domestic partner). You can self-certify that the abuse occurred.
- You have the option to repay the domestic abuse distribution. If you do so within three years, you may be eligible for a refund of taxes paid on the repaid amount.
Note: The IRS considers“domestic abuse” to be “physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently, including abuse of the victim’s child or another family member living in the household.”
Taxes on a 401(k) withdrawal
When you withdraw from your retirement savings account, the federal tax you pay depends on several factors including account type, your age, and federal tax bracket. (For example, Roth 401(k) withdrawals are tax-free, since contributions were made with after-tax dollars.)
Under the new rules for domestic abuse and personal expense distributions, as mentioned above, the ordinary income tax you would typically pay won’t be increased by the normal 10% tax penalty. But keep in mind that there’s a possibility your state may tax retirement distributions.
Retirement plan distributions are reported on Form 1099-R. This form typically comes from the retirement plan and shows the amount you received and the taxes withheld. Those amounts are reported on your federal income tax return.
Early withdrawal penalty: Bottom line
These SECURE 2.0 changes could be helpful for those needing to make early emergency withdrawals from a retirement savings account. However, it's important to consider the potential tax and financial effects of accessing retirement savings early.
Evaluate available funding sources and consult with a qualified tax or financial planner to see how they might affect you.
Related
- New Roth 401(k) Rule Changes for 2024
- Types of Income the IRS Doesn't Tax
- Average 401(k) Balance by Age
- SECURE 2.0 Act Summary: What You Need to Know
FAQs
Annual penalty-free withdrawals: Individuals can withdraw up to $1,000 annually from their qualified retirement plans, such as 401(k), 403(b), 457(b), or IRAs (including SEP and Simple IRAs), without incurring the 10% tax penalty.
What are the new 401k withdrawal rules for 2024? ›
In 2024, you can cash out as much as $1,000 from a traditional 401(k) or IRA to cover an urgent need. And here's a big change: You get to define what counts as an emergency. More Americans are raiding retirement accounts for emergency cash.
Is there a way to avoid penalty on 401k withdrawal? ›
Common penalty-free exceptions
- You are terminally ill.
- You become or are disabled.
- You gave birth to a child or adopted a child during the year (up to $5,000 per account).
- You rolled the account over to another retirement plan (within 60 days).
- Payments were made to your beneficiary or estate after you died.
Specifically, you can withdraw up to $1,000 from your qualified plan (e.g., 401(k), 403(b), 457(b)) or IRA (including SEP, Simple IRA) once each calendar year without penalty. You will still have to pay ordinary income taxes on the withdrawal.
What are the new rules for 401k withdrawal? ›
If you withdraw from an IRA or 401(k) before age 59½, you'll be subject to an early withdrawal penalty of 10% and taxed at ordinary income tax rates.
Can I withdraw $1000 from my 401k without penalty? ›
But as of the start of this year, you can make a one-time $1,000 withdrawal from your 401(k), traditional IRA or other qualified tax-advantaged retirement account without penalty to be used for “unforeseeable or immediate financial needs,” such as personal or family emergency expenses, according to the Secure 2.0 Act.
How do I avoid 20% tax on my 401k withdrawal? ›
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
What is the loophole for 401k withdrawal? ›
31, 2022.
- IRS rules dictate that investors can withdraw funds from their 401(k) account without penalty only after they reach age 59½, become permanently disabled, or are otherwise unable to work. ...
- Home-buying expense withdrawals are commonly used for a down payment to secure a mortgage or closing costs.
Bottom Line. You can't take distributions from your 401(k) without paying taxes. And, if you take distributions before turning 59.5, you'll also pay a 10% penalty. You can temporarily access 401(k) funds by using rollovers and 401(k) loans.
At what age can I withdraw from my 401k without penalty? ›
If you turn 55 (or older) during the calendar year you lose or leave your job, you can begin taking distributions from your 401(k) without paying the early withdrawal penalty. However, you must still pay taxes on your withdrawals.
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
What are the exceptions to the 10% early withdrawal penalty? ›
Exceptions to the 10% additional tax
| Exception | The distribution will NOT be subject to the 10% additional early distribution tax in the following circ*mstances: |
|---|
| Homebuyers | qualified first-time homebuyers, up to $10,000 |
| Levy | because of an IRS levy of the plan |
| Medical | amount of unreimbursed medical expenses (>7.5% AGI) |
21 more rowsAs per the updated regulations from the RBI (Reserve Bank of India), with effect from 1st January 2022, users of most banks can withdraw cash from ATM five times per month. These five transactions are inclusive of both financial and non-financial (balance inquiry, mini statements etc.)
What are the new 401k rules for 2024? ›
Roth 401(k) contribution limits 2024
As Kiplinger has reported, If you are younger than 50, the maximum amount you can contribute to a Roth 401(k) for 2024 is $23,000. (That contribution limit is up $500 from 2023. ) For 2024 "catch-up" contributions, the maximum contribution is $30,500.
How to avoid penalty on 401k withdrawal? ›
Withdrawals from a 401(k) to pay for unreimbursed medical expenses that exceed 7.5% of an individual's adjusted gross income (AGI) may be exempt from the early withdrawal penalty. Qualified medical expenses include payments for the diagnosis, cure, mitigation, treatment or prevention of disease.
What is the best way to withdraw money from a 401k after retirement? ›
The 4% rule is a strategy that says you should withdraw 4% of your retirement savings in your first year of retirement. In subsequent years, tack on an additional 2% to adjust for inflation. For example, if you have $1 million saved under this strategy, you would withdraw $40,000 during your first year in retirement.
What are the changes in the Secure 2.0 Act 2024? ›
Beginning in January 2024, beneficiaries of 529 college savings plans can roll over money in their account to a Roth IRA. The amount of the 529 plan rollover must stay within the annual Roth IRA contribution limit ($7,000 for 2024) and cannot exceed the lifetime maximum of $35,000.
What is the 401k strategy for 2024? ›
Move #1: Take your workplace retirement plan contributions to the max. For 2024, the IRS has announced a $500 increase in the contribution limits for 403(b)s and 401(k)s up to $23,000. * Contributing as close to this maximum as possible is a great way to stay or get on track for your retirement goals.
What qualifies as a hardship withdrawal for a 401k? ›
For example, some 401(k) plans may allow a hardship distribution to pay for your, your spouse's, your dependents' or your primary plan beneficiary's: medical expenses, funeral expenses, or. tuition and related educational expenses.
