Experts: How To Use Retirement Savings in Emergencies — $1,000 Can Be Yours, Penalty-Free - Understanding the Factors of Production: Key Elements in Finance

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Your retirement savings account is meant to be an untouchable, long-term investment designed to compound and grow over decades.

To encourage this mindset, the IRS slaps a 10% early withdrawal penalty on any distributions taken before age 59 ½, with limited exceptions. However, a small but important exception went into effect on Jan. 1, 2024, and many investors may still be unaware of it.

Here’s a look at the new way that you can draw $1,000 from your retirement savings account for an emergency, penalty-free, and what experts think about it.

Primary Rule Regarding Early Distributions

The general IRS rule is that distributions from any retirement plan before age 59 ½ triggers an additional 10% tax for the “early” or “premature” distribution. This tax is in addition to the ordinary income tax that applies to most retirement plan withdrawals.

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There have long been a number of standard exceptions to this penalty. Common examples include the following:

Up to $5,000 for per child for qualifying adoption or birth expenses
Up to $22,000 for economic losses from qualifying federal disasters
Payouts under a qualified domestic relations order
A series of substantially equal payments
Up to $10,000 for qualified first-time homebuyers
Health insurance premiums paid while unemployed
If an employee separates from service after reaching age 55 (or 50 for certain state or governmental plans)

Barring these and some other provisions for rare occurrences, all other early distributions are hit with the 10% additional tax.

New Emergency Provision for 2024

Beginning Jan. 1, 2024, new legislation allowed for penalty-free withdrawals of $1,000 from retirement plans for financial emergencies. Those withdrawals would not be subject to the usually 10% early withdrawal penalty for distributions before age 59 ½. However, there are some important restrictions on those withdrawals:

First, taxpayers are only allowed one $1,000 withdrawal per year. If that money isn’t replaced within three years, no additional withdrawals during that time period would be allowed.

Next, those distributions, while avoiding the 10% early withdrawal penalty, would still be fully taxable as ordinary income.

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Lastly, account holders would have to self-certify with their retirement plan administrator, in writing, that the money was required for emergency purposes.

What Do the Experts Say?

Conventional wisdom suggests that it’s generally a mistake to take money out of a retirement plan before age 59 ½. However, the new emergency provision garners support from many financial experts.

For example, “Your Best Financial Life: Save Smart Now for the Future You Want” author Anne Lester believes that taking this type of $1,000 withdrawal can be appropriate in certain situations.

“I don’t think it’s terrible to take this money out of your retirement savings if you really need it and don’t have it,” she said, per CNBC. “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.”

Bear in mind that experts still suggest you don’t look at your retirement plan as a primary source of funds, even for pre-retirement emergencies. While Lester endorses a one-time use of the provision, she emphasizes that it should only be considered for a real financial emergency.

“It’s not for getting FOMO and wanting to go 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,” Lester warned.

Others suggest that even a $1,000 emergency withdrawal should be avoided due to the financial consequences. Alex Beene, a financial literacy instructor for the state of Tennessee, told Newsweek in a recent interview that taking such a withdrawal will still create a tax liability — requiring the need of additional funds — and also slow the compound growth of your retirement account balance.

He and other experts suggest trimming expenses or boosting your income instead.

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