As consumer confidence falters, government layoffs dominate the news and recession warning signs start blinking, it’s smart to think about what you might do if you need additional cash. Nearly half of adults don’t have three months of emergency savings, according to the Federal Reserve’s latest survey on the Economic Well-Being of U.S. Households. And there are indications—such as a rising credit card delinquency rate—that more folks are having problems paying their bills today than when the Fed did that survey more than a year ago.
One source Americans consider tapping in an emergency or when they’re otherwise short of cash? Retirement accounts. It makes sense, since for many workers, retirement accounts represent most of their liquid savings. At the end of 2024, according to the Investment Company Institute, Americans held $15.2 trillion in individual retirement accounts (IRAs) and another $12.4 trillion in workplace defined contribution plans such as 401(k) 403(b) and 457 plans.
In general, a retirement plan can begin distributing money after a participant reaches a certain age—usually 59-1/2. If you take funds earlier, you usually must pay a 10% penalty (some exceptions apply, keep reading) in addition to normal federal income tax on the distribution. Truth is, the rules on early withdrawals are complicated and seem to be constantly changing. Here’s an up-to-date briefing on what you need to know, plus a handy, quick-look table (near the bottom) with some of the exceptions.
Hardship Distributions
A hardship distribution is a pre-retirement withdrawal from your 401(k) plan, 403(b) plan, or 457(b) plan due to an immediate and heavy financial need. The withdrawal amount is limited to the amount needed to satisfy that financial need and is generally subject to the 10% early withdrawal penalty. The key benefit here is getting access to your funds early, not getting out of the 10% penalty tax.
There is no bright-line definition for hardship—it’s determined by the employer under the terms of the retirement plan and based on facts and circumstances. However, the IRS has made clear what won’t qualify—consumer purchases, such as boats or televisions, for example, are typically not considered immediate and pressing financial needs.
Some guidance about what qualifies exists under the “safe harbor” rules in the IRS regulations. For example, the IRS says that you are deemed to have an immediate and serious financial need if the distribution is for medical expenses incurred by you, your spouse, dependents, or beneficiary. Costs directly associated with purchasing a principal residence—excluding mortgage payments—or payments needed to prevent eviction or foreclosure of a principal residence also qualify, along with certain expenses to repair damages to a principal residence. Additionally, tuition, related educational fees, and room and board costs for the upcoming 12 months of postsecondary education, as do funeral expenses for you, your spouse, children, dependents, or beneficiary.
A hardship distribution must be limited to the amount needed to meet the need. This requirement is satisfied if the distribution doesn’t exceed the cost of the need, and you cannot reasonably obtain the funds from another source. Your employer can generally rely on your written statement indicating that your need cannot be met with other available resources, including insurance or other reimbursement, liquidation of assets, current pay if you pause your elective deferrals and after-tax employee contributions, and plan loans or reasonable commercial loans. However, you are not obligated to use other resources if doing so would make matters worse.
Not all funds in the plan are available for withdrawal. In a retirement plan like a 401(k) plan, hardship distributions are generally allowed only from accumulated elective deferrals (not from earnings on those deferrals), employer nonelective contributions (profit-sharing contributions), and standard matching contributions.
Hardship distributions aren’t tax-free. They are subject to federal income taxes unless they are Roth accounts. They may also be subject to a 10% additional tax on early distributions. If you take a hardship distribution, you aren’t allowed to put it back into the plan or roll it over to another plan or an IRA.
Expect to see more hardship withdrawal options offered as part of retirement plans as more Americans take advantage. According to a recent Vanguard study, 4.8% of account holders took hardship withdrawals last year, up from 3.6% in 2023.
Note that the term “hardship withdrawal” doesn’t appear in the IRA rules—in fact, you can get at your IRA money at any time, if you’re willing to pay an early withdrawal penalty. But some early withdrawals from IRAs for specific uses are exempt from the 10% penalty. Those exemptions include circumstances that might relate to hardship, such as huge medical bills or the need to pay health insurance premiums after a layoff, as well as college tuition and such happy events as the first-time purchase or of a house and the birth or adoption of a child.
New $1,000 Penalty Free Emergency Withdrawal
As part of the SECURE 2.0 Act, you can now make a $1,000 penalty-free withdrawals for emergency personal expenses as long as your retirement plan allows it—you should always review the language in your 401(k) plan since the rules can vary. However, distributions are still subject to ordinary taxes on your Form 1040.
Emergency personal expense distributions are withdrawals made from an eligible retirement plan (typically a 401(k), 403(a), 403(b), or 457(b) plan, or an IRA) to address unforeseen or immediate financial needs related to personal or family emergency expenses.
Emergency personal expense distributions are subject to three limitations:
- You cannot treat more than one distribution per calendar year as an emergency personal expense;
- The withdrawal limit is $1,000 (not adjusted for inflation) or your non-forfeitable accrued benefit under the plan minus $1,000, whichever amount is less; and
- If you request an emergency personal expense distribution in any calendar year, you cannot do so again during the next three calendar years unless the previous distribution is repaid or the total of the elective deferrals and employee contributions to the plan after the distribution equals at least the amount of the unpaid previous distribution.
Since an emergency for one person may not qualify as an emergency for another, the tax code allows a plan administrator to rely on an employee’s written certification that the emergency is valid. Examples for guidance include medical care, accidents or loss of property due to unforeseen circumstances, imminent foreclosure or eviction from a primary residence, the need to cover burial or funeral expenses, auto repairs, or any other essential emergency personal expenses.
You can repay the distributions. The rules are the same as for repaying qualified birth or adoption distributions. This means that you can repay an emergency personal expense distribution at any time within three years starting the day after the distribution was received.
New $10,000 Penalty Free Withdrawal For Domestic Abuse Victims
The SECURE 2.0 Act also added a new section of the tax code—section 72(t)(2)(K)—which provides an exception for domestic abuse victims.
Under this provision, you can withdraw up to $10,000 (adjusted for inflation) or 50% of the current value of the plan’s non-forfeitable accrued benefit (vested accrued benefit), whichever is lower.
A distribution from an applicable eligible retirement plan to a domestic abuse victim generally meets the new exception. To qualify, the distribution must be made within one year of the date on which the individual is a victim of domestic abuse by a spouse or domestic partner. The term “domestic abuse” is defined in the tax code as “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 by means of abuse of the victim’s child or another family member living in the household.”
The repayment rules are the same as those for repaying qualified birth or adoption distributions. That means you can repay a domestic violence distribution at any time during the three years beginning on the day after the date on which the distribution was received.
To meet the requirements, check the box on the distribution request form to certify that you are eligible for a domestic abuse victim distribution. Your certification must be in writing.
If your retirement plan does not allow distributions for domestic abuse victims, you can classify the distribution as a domestic abuse victim distribution on your federal income tax return, provided that it meets the necessary criteria.
For more information on recent changes, check out Notice 2024-55.
Retirement Plan Loans
Profit-sharing plans and 401(k), 403(b), and 457(b) plans may legally offer loans, but are not required to. Meanwhile IRAs (including SEP and SIMPLE IRAs) may not offer loans.
A retirement plan loan works more or less like a standard loan—you must apply, and you’ll only be accepted if you meet the criteria (the availability and terms will be found in the plan.) And, like a traditional loan, a retirement plan loan must be paid back (generally, the repayment term may not exceed five years, and the borrower must make payments at least quarterly—an exception applies if the employee uses the loan to purchase a primary residence).
Repayment terms can vary but must include a repayment schedule. If the plan requires it, you may have to pay back the loan balance if you leave your job or if the plan is terminated. If you can’t repay the loan, the employer will treat the balance as a distribution and report it to the IRS. If that happens, you can avoid the immediate income tax consequences by rolling over all or part of the loan’s outstanding balance to an IRA or eligible retirement plan by the due date (including extensions) for filing your federal income tax return for the year in which the loan is treated as a distribution (report the rollover on Form 5498).
The maximum loan amount is 50% of your vested account balance or $50,000, whichever is less. An exception may apply if 50% of the vested account balance is less than $10,000—in that case, you can borrow up to $10,000 (plans are not required to include this exception). Loans exceeding the maximum amount (or not following the required repayment schedule) are considered “deemed distributions” and may be subject to a 10% penalty.
Other rules may apply. For example, some qualified plans require a participant’s spouse’s written consent before giving a loan over $5,000. Other qualified plans may not require the participant’s spouse to sign for a loan, regardless of amount, if the plan meets certain criteria.
The money is not taxed for federal income tax if the loan meets the rules and the repayment schedule is followed.
Consider Other Options
The tax consequences can be complicated with specific deadlines and recordkeeping requirements—and plan documents can vary. It’s important to pay attention and understand what might be taxable or subject to an early withdrawal penalty. Those taxes (plus interest and penalty where applicable) can add up, making a bad situation worse.
Here’s a look at some exceptions that might apply:
When considering withdrawals or loans from your retirement account, keep in mind that there are consequences beyond immediate tax implications. Taking money out of your retirement plan—especially if you don’t plan to pay it back—reduces the balance of your account and the potential for future growth. Before pulling out those funds, consider other options like payment plans or credit cards—the IRS will accept either of those, for example.
If you’re confused or have questions, don’t simply guess. Help is available. Check with a tax professional or your benefits administrator for details.
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