More people are taking early emergency withdrawals from retirement savings accounts. New IRS rules might offer some relief.
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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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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.
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.
Revised retirement account withdrawal rules also offer tax relief to victims of domestic abuse who find themselves in need of financial assistance.
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.”
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.
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.
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Senior Tax Editor, Kiplinger.comAs the senior tax editor at Kiplinger.com, Kelley R. Taylor simplifies federal and state tax information, news, and developments to help empower readers. Kelley has over two decades of experience advising on and covering education, law, finance, and tax as a corporate attorney and business journalist.
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