IRS Provides Guidance on Penalty-Free Withdrawals From Retirement Plans

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Some good news for cash-strapped retirement savers who may need to meet a financial emergency but do not want to incur interest or penalty charges when accessing money from a retirement plan: The IRS recently released guidance on a provision included in the SECURE 2.0 legislation that permitted retirement savers to withdraw up to $1,000 penalty free from their retirement account under certain specified circumstances.

The IRS guidance says that withdrawals are permitted for an "unforeseen or immediate financial need" and notes that whether an individual has an unforeseeable or immediate financial need relating to necessary personal or family expenses is determined by the relevant facts and circumstances for each individual. The IRS guidance additionally notes that factors to be considered include, but are not limited to, whether an individual or a family member has expenses relating to "medical care, accident or property losses due to casualty, imminent foreclosure or eviction from primary residence, burial or financial expenses, auto repair and any other necessary emergency responsibility."

For purposes of determining whether an individual has an unforeseeable or immediate financial need, the plan administrator may rely on the employee's certification that they are eligible for an emergency personal expense distribution.

However, there are several issues related to these withdrawals that anyone thinking of taking one should understand. They include:

• Only one penalty-free emergency withdrawal per year is permitted.
• Participants may not take a second emergency withdrawal for three calendar years unless they either repay the original emergency withdrawal to the plan or the participants' contributions to the plan following the withdrawal equal the amount of the personal emergency withdrawal.
• Withdrawals that would reduce the account balance to less than $1,000 are not permitted.
• Those who take emergency cash from their retirement account have three years from the day after the withdrawal to put the money back into their retirement account. However, there is no penalty for failing to repay the amount withdrawn back into the retirement plan account.
• Nonetheless, income taxes are due on the amount taken as emergency cash.
• This $1,000 emergency expense provision is optional for employer plans. Not every plan is expected to adopt it.

Factors to Consider When Taking a Withdrawal or a Loan From a Tax-Deferred Retirement Account
Plan participants should be aware that there are several drawbacks to taking plan withdrawals. In particular, participants have to pay income taxes on pretax emergency withdrawals.

In the case of both withdrawals and loans, plan participants lose growth opportunities while the money is not invested in the plan. When participants take a loan from their retirement plan, they will be repaying the loan plus interest over time. However, since participants are the ones paying the interest on the borrowed money, no actual return is earned. In addition, participants have to use after-tax dollars to repay a plan loan and then pay income tax on the money when it is distributed from the plan at retirement -- essentially increasing the cost of borrowing.