The majority of Americans wouldn’t be able to cover an unforeseen $1,000 expense with money from their own savings, according to Bankrate’s 2024 emergency savings report.
But a relatively new rule may offer some relief. As of the beginning of this year, it has become a lot easier to withdraw up to $1,000 from a retirement investment account, such as a 401(k), individual retirement account or 403(b), to cover an unexpected emergency expense without tax penalties.
However, using this option too much may derail your long-term retirement planning strategy if you’re not careful.
“If you need to use it, you shouldn’t feel ashamed because stuff happens in everybody’s life,” says Anne Lester, a retirement expert and author of “Your Best Financial Life: Save Smart Now for the Future You Want.” But don’t overuse it, she adds.
Generally, you’ll face a 10% penalty for withdrawing money from retirement savings before you reach the age of 59½.
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.
DON’T MISS: Achieve Financial Wellness: Be Happier, Wealthier & More Financially Secure
However, there are a few caveats to be aware of.
For one, you can only make one $1,000 withdrawal per year. But if you don’t replace that amount in your retirement account in full or through regular deposits within three years, you won’t be able to make another $1,000 withdrawal during that repayment period. Additionally, you’ll need to pay income tax on your withdrawal.
And you’ll need to self-certify in writing with your retirement plan administrator that you need the money for an emergency.
“It’s not for getting FOMO and wanting to on a trip with your friends,” Lester says. “The emergency would be if your spouse lost their job or you had an urgent medical bill or something like that.”
Keeping your retirement savings on track
Although making this type of emergency withdrawal from your retirement savings to pay for a “one-off” unexpected bill like a pricey car repair may be better than racking up expensive credit card debt, you should still be wary of using it too much, Lester says.
“Doing it one time isn’t what’s going to derail your retirement savings,” she says. “But doing it over and over again and not paying it back can.”
By constantly making these types of withdrawals from your retirement account without repaying them, you’re losing out on the opportunity for that money to grow through the power of compound interest. That could leave you with inadequate savings by the time you reach retirement age.
It’s important to build up your emergency fund so that you can pull money from that for unexpected expenses instead of money you’re supposed to be saving for your retirement years.
“I don’t think its terrible to take this money out of your retirement savings if you really need it and don’t have it,” Lester says. “But your goal should be to pay it back and work on growing your emergency savings so you don’t end up in that position again.”
Want to stop worrying about money? Sign up for CNBC’s new online course Achieve Financial Wellness: Be Happier, Wealthier & More Financially Secure. We’ll teach you the psychology of money, how to manage stress and create healthy habits, and simple ways to boost your savings, get out of debt and invest for the future. Start today and use code EARLYBIRD for an introductory discount of 30% off through Sept. 2, 2024.
Plus, sign up for CNBC Make It’s newsletter to get tips and tricks for success at work, with money and in life.