As a rule, withdrawals made from retirement plans before age 59 1/2 will incur a 10% penalty; this includes distributions from IRAs, tax-deferred employer plans such as 401(k) and 403(b) plans, and traditional pension plans.
The 2022 Secure Act 2.0 added new exceptions and expanded existing ones in order to help people access money when needed. Let’s examine some of them.
Hardship Distributions
At times of hardship, taking money out of a 401(k) plan may provide much-needed financial support. Unfortunately, doing so exposes your funds to income taxes and limits any long-term growth potential that would have come with having it in a tax-sheltered account.
Withdrawals made before age 59 1/2 from traditional IRAs or employer-sponsored retirement accounts are subject to a 10% federal income tax penalty on top of regular taxes; however, exceptions exist which allow distributions without incurring this fee.
These include paying medical expenses, higher education costs, purchasing a first home and funeral costs. Under SECURE Act 2.0 there were some additional qualifying expenses added to this list and documentation requirements were relaxed for hardship withdrawals; for example the old “actual knowledge” requirement has been replaced with one which relies on participant-provided summaries that include certain information to establish why distribution was needed.
Higher Education Expenses
Most tax-advantaged savings programs, including 529 college savings plans and Coverdell Education Savings Accounts, define “qualified higher education expenses” (QHEE) as tuition and fees required to enroll or attend an eligible educational institution, room and board costs associated with at least half-time enrollment, student activity fees to support on-campus activities as qualifying expenses as well as any student activity fees that you pay to support such activities may also qualify as QHEEs.
The IRS defines “required expenses” narrowly, restricting them to fees required by your school for enrollment or attendance. Course books and supplies that are specific to that course qualify as required expenses as do equipment such as computers (if required as part of your coursework) or other technology; non-educational software used for sports, gaming or hobbies does not qualify; although software designed specifically to teach job skills courses could qualify. You can find more details regarding QHEE expenses by reviewing IRS Publication 970.
Buying a First Home
Acquiring your first home can be both exciting and a major financial undertaking, yet the IRS makes it easier for first-time homebuyers to access funds from retirement accounts for this purchase.
Typically, withdrawals from an IRA or 401(k) without incurring the 10% penalty can be used to purchase your first home without incurring it as the primary residence – including for reservists called to active duty. Your primary residence can include anything from conventional houses to something unique like living aboard a boat full time.
However, if you use the funds for anything other than purchasing your first home, a penalty will apply. There may be exceptions, however: for purchases related to certain unforeseen emergency expenses and withdrawals made related to domestic violence as specified by the 2022 Safe Act; penalties may be waived in these instances provided participants self-certify their distributions as fitting into these categories.
Terminally Ill
People living with terminal illness often have medical conditions that cannot be treated and will eventually lead to their deaths. At such times, accessing money may become very stressful; accessing funds could allow for the payment of bills and planning for death as well as taking measures like getting another job or selling possessions to reduce debt can all help ease that pressure.
SECURE 2.0 allows participants who are terminally ill to withdraw funds without incurring a 10% penalty (though they must self-certify as such). The definition of terminal illness under SECURE 2.0 includes anything diagnosed by a physician that will result in death within 84 months or less – similar to distributions from an IRA. Plans offering SECURE 2.0 to their current employees only will have access to this feature; former employees or beneficiaries do not qualify, and it does not restrict withdrawal amounts or timing.
