You Can Now Withdraw From Your 401(k) Penalty-Free (But You Shouldn’t)

NEWS & TRENDING - INVESTING NEWS
Early withdrawals may leave you with lower savings and higher tax bills.
Updated April 11, 2024
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A Trump-era bill designed to provide increased access to tax-advantaged retirement accounts recently got a facelift, and though one of the new rules might be alluring, experts warn against taking advantage of it. The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was signed into law in 2019 and changed a number of retirement savings rules, including raising the minimum disbursement age, allowing new parents to withdraw from retirement accounts penalty-free, and allowing long-term part-time workers to contribute to 401(k) plans. The bill was meant to increase access to savings alternatives and help older Americans hold on to their money for longer.

At the end of 2022, certain aspects of the SECURE Act were expanded. SECURE 2.0 introduced a number of key changes to the existing legislation, with one key rule change that seems to fly in the face of the bill’s original intention – employees can now withdraw money from their 401(k) retirement without penalties, though a few rules do apply.

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SECURE 2.0 withdrawal rules

Vitalii Vodolazskyi/Adobe 401k written on an envelope with dollars

Historically, employees younger than 59 ½ could withdraw funds from retirement accounts for personal or family emergencies. Those withdrawals would incur a 10% penalty and be subject to income tax.

Beginning this year, employees can withdraw up to $1,000 per year penalty-free from their retirement funds. The only requirement is that employees self-certify that the funds are needed for a personal or family emergency.

Victims of domestic abuse are allowed to withdraw up to $10,000 without incurring a penalty.

Withdraw with caution

Alexandra W/peopleimages.com/Adobe discussion for budget or retirement

While $1,000 may be tempting for families struggling to make ends meet, experts suggest that these withdrawals could hinder their financial health in the future.

Money withdrawn early cannot accrue interest and compound over time, resulting in a net loss greater than the initial withdrawal amount. That net loss could result in workers not retiring as early as planned.

And although employees may not be required to pay a penalty on emergency withdrawals, they can still anticipate paying taxes on those funds. "This rule was made with the best of intentions, but I still think for most Americans, it's a bad idea," Alex Beene, a financial literacy instructor for the state of Tennessee, told Newsweek."I would exhaust every other budget option with money I currently have than tapping into retirement savings, regardless of how dire the financial hardship situation is.”

Other new things in Secure 2.0

tashatuvango/Adobe drawer with 401K file

A few other notable changes take effect with SECURE 2.0 that will affect how Americans save for retirement.

Before SECURE 2.0, employers who offered 401(k) matching were required to contribute to employee accounts with pretax dollars, and those funds had to pass through a pretax account like a traditional 401(k) before transferring into the employee’s account.

Now, employers can transfer the pretax matching funds directly into an employee’s 401(k) account, where the money will grow tax-free over time and not be subject to taxed distributions in retirement.

Beginning in 2025, employers will be required to enroll employees in a retirement plan automatically, and any company starting a new 401(k) or 403(b) plan will automatically enroll employees at a contribution level of at least 3%. Businesses less than three years old or with fewer than ten employees are not subject to automatic enrollment rules.

Additionally, employees who earn less than $150,000 and don’t own at least a 5% stake in a company can link their retirement fund to an emergency savings account. Contributions will be limited to $2,500 per year, and up to four withdrawals per year will be tax- and penalty-free.

Bottom line

Cozine/stock.adobe.com retirement savings clock ticking

The ability to withdraw money from a 401(k) may assist employees with the increased cost of living in the short-term future, but it could also hinder their overall financial health in the long run.

Upgrades to the SECURE Act will affect employees, but employers will also have new rules to contend with as enrollment and contribution regulations change for them, too.

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Author Details

Taylor Bushey Taylor Bushey is a professional writer with a background in the banking industry. She also covers topics including home, wellness, lifestyle, fashion, and beauty.

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