Americans will soon be able to tap their retirement accounts for emergency expenses.
Under the $1.7 trillion omnibus bill President Joe Biden signed on December 29, rules related to hardship distributions from 401(k) plans will change.
Hardship withdrawals allow workers to access their 401(k) savings before retirement if they face an “immediate and heavy” financial need. These withdrawals come with disadvantages, as income tax may be owed on the withdrawal and those younger than 59 years and 6 months generally face a 10% penalty for early withdrawal.
Under the new rules expected to go into effect in 2024, workers will be allowed to make one withdrawal of up to $1,000 a year from a 401(k) or individual retirement account for personal or family expenses. The 10% penalty will be waived, and Americans can self-certify that they need the funds for an emergency.
Those who utilize the new rules and take emergency funds can repay the initial distribution or make regular deposits matching the withdrawn amount within three years. Failing that, workers cannot take more emergency withdrawals within three years.
With record inflation, rising unemployment, soaring household debt, and a recession looming, many Americans are worried about their financial situations.
According to data from Vanguard Group, the number of Americans making hardship withdrawals hit a record high in October.
With inflation squeezing budgets and higher interest rates weighing on credit card balances, households may not have the cash on hand for emergencies: a recent CNBC report suggested that 56% of Americans could not cover a $1,000 emergency expense.
Vanguard reported that about 25,000 workers with a 401(k) plan took a new hardship distribution in October, the largest share it has seen since tracking the data in 2004. The group also noted higher numbers of loans and “non-hardship distributions” in 2022, indicating that households need more liquidity to face uncertainties.
“People are feeling the pinch from inflation,” said Phillip Chao, a principal and chief investment officer at Experiential Wealth. Yet Chao also noted that savers are not always responsible and tend to think of their 401(k) “more like a piggy bank.”
During the pandemic, Congress authorized COVID-related withdrawals — also self-certified — of up to $100,000 from 401(k) plans through the CARES Act.
Additionally, the Bipartisan Budget Act passed in 2018 erased the need for workers to first take a 401(k) loan before being able to make a hardship withdrawal.
Even though it will now be easier to take a hardship distribution, it is still generally not advised.
“[It’s] a terrible idea to take money out of your 401(k),” said Ted Jenkin, co-founder of oXYGen Financial and a certified financial planner.
Hardship loans are typically not paid back, meaning future investment earnings in retirement accounts are permanently lost unless workers can make up for the withdrawal later with higher savings rates.