Co-authored by Adam Snyder.
American workers often lack funds they need to cover unexpected expenses. Dipping into retirement plan savings with hardship withdrawals is an expensive and potentially tax-inefficient way to secure cash.
As inflation and a cooling economy continue to impact the American workforce, hardship withdrawals from 401(k) plans have hit a nearly 20-year high, according to Vanguard.
Fortunately, recently passed retirement plan legislation, referred to as "SECURE Act 2.0", includes several optional changes to retirement plans aimed to help households both build and access emergency savings without punitive taxes and administrative burdens.
As it relates to "emergency" savings and distributions, plan sponsors should be aware of the following changes permitted (but not required) under SECURE Act 2.0:
- Employers may rely on employee self-certification that deemed hardship distribution conditions are met. Effective immediately.
- Emergency savings accounts linked to retirement plans. 401(k) and 403(b) plans may offer emergency savings accounts for their non-highly compensated employees. Such accounts would be funded by Roth (like) employee contributions up to a maximum of $2,500 (indexed for inflation). Only non-highly compensated employees could contribute to such accounts. Distributions would be treated as non-taxable. Effective for plan years beginning after December 31, 2023.
- Withdrawals for certain emergency expenses. Early withdrawals from 401(k) plans are subject to an additional 10% early penalty tax, unless an exception applies. SECURE Act 2.0 brings a new exception-- employees will be able to take a distribution of up to $1,000 per year for emergency expenses with no 10% excise tax. There is also a new exception for distributions of up to $10,000 for victims of domestic abuse. Effective for withdrawals made after December 31, 2023.
- More sources for 403(b) plan hardship distributions. 403(b) plans continue their alignment with 401(k) plans, as SECURE Act 2.0 now allows all amounts in 403(b) plans to be available for hardship distribution. Effective for plan years beginning after December 31, 2023.
