New 401(k) Rules Let You Withdraw $1,000 Without Penalty — but Should You?

A broad definition of ‘emergency’

What constitutes an emergency under the new rule? That’s more or less up to you. “The meaning of emergency withdrawals is pretty broad,” says Lindsay Theodore, a thought leadership senior manager at financial services company T. Rowe Price. “It could be for any number of things, like auto repair, burial expenses or medical bills.”

You do not need to provide proof of your emergency, or even say what it is, but you may have to give your plan administrator your word, in writing, that the financial need is real.

The 2024 edition of the Transamerica Center for Retirement Studies’ annual report on the retirement outlook for middle-class families (defined as households with incomes between $50,000 and $199,000) offers insights into what Americans consider to be withdrawal-worthy events. The top reasons people gave for taking a “hardship withdrawal” from a retirement plan included:

• Losses due to a natural disaster (18 percent of survey respondents)
• Medical bills (17 percent)
• Home purchase (15 percent)
• Tuition or other education expenses (13 percent)
• Home repairs (11 percent)
• Avoiding eviction (10 percent)
• Burial or funeral costs (9 percent)

Along with making it easier to access retirement funds, the new rule could ease concerns for consumers who want to increase their IRA or 401(k) contributions but don’t want to tie that money up until they retire for fear a more immediate need will arise. Nearly three in five respondents to the FinanceBuzz survey said they would consider or have considered taking an emergency withdrawal given the new penalty-free rule.

Weigh the pros and cons

There are some drawbacks. “Spending out of your retirement plan not only reduces the amount you have saved but also your earning power,” Rayll says — the money you withdraw is no longer earning compound interest. If you kept it invested at a 7 percent annual rate, that $1,000 would be worth nearly $4,000 in 20 years.

You’ll also still have to pay federal and possibly state taxes on the withdrawal, so even if you take out $1,000 you would have less than that amount to put toward your emergency.

For those reasons, you should use the rule to fund a need, not something you might want, like a vacation or a luxury car, says Jaime Eckels, a partner at Plante Moran Financial Advisors in Auburn Hills, Michigan. “These expenses can often be managed through other means and do not justify compromising your retirement savings,” she says.

But we all know life happens, and the new rule was created to give workers another option when it does. For example, if you’re having trouble paying for a loved one’s medication or need a major auto repair so you can get to and from work, taking the $1,000 withdrawal may be worth exploring, Theodore says.

Consider alternatives

Before you contact your plan administrator to request a withdrawal, financial pros suggest that you consider other options. Among them:

Explore payment plans. “For things like a medical bill or a burial expense, a lot of times the funeral home or the hospital system, the medical provider, will work with you to come up with some type of reasonable payment plan,” Theodore says. That could allow you to spread a big bill over several months.

Compare prices for services. If your emergency requires you to buy something expensive, such as a new furnace or a costly prescription, shop around for an offering that is more within your means or a service that offers discounts. For example, discount prescription cards and patient assistance programs could lower your drug costs enough to fit your budget, alleviating the need for a withdrawal. 

Borrow against your retirement plan instead. Consider whether you can pay the money you withdraw back within three years, Koebert suggests. If that's the case, taking out a loan from your 401(k) might be the better option — you won’t owe taxes on the money, provided you pay it back.But perhaps the best way to lessen your chances of needing to withdraw money from your retirement account is to build up an emergency fund that you can tap when an unexpected expense crops up.

Say you get paid every other week. If you can set aside $45 from every paycheck for a rainy-day fund, you’ll have more than $1,000 after a year that you can use without compromising your future finances, Theodore notes.

But “if your retirement account is the only source you have and you do have an emergency,” she adds, “it's nice that this option is now available for those who really need it.”