New retirement account rules make it easier to tap savings early for emergencies (Video)

It will soon be easier for cash-strapped Americans to tap their retirement savings for emergency expenses.

President Joe Biden is poised to sign a $1.7 trillion bill that amends rules related to so-called hardship distributions from 401(k) plans.

Current rules around hardship withdrawals allow workers to access their 401(k) savings plans before retirement for an “immediate and heavy” financial need. Workers may owe income tax on that withdrawal, and those under age 59½ generally owe a 10% tax penalty for early withdrawal.

New rules let savers make one withdrawal of up to $1,000 a year for personal or family emergency expenses. The measure — which takes effect in 2024 and also applies to individual retirement accounts — waives the 10% tax penalty. Americans can self-certify in writing that they need the funds for an emergency.

Taxpayers have the option to repay the funds within three years. They can’t take more emergency withdrawals within three years unless they repay the initial distribution or they make regular deposits that at least match the withdrawn amount.

The legislation also lets 401(k) savers self-certify that they meet the condition for a typical hardship distribution, which is the case under current rules in some but not all 401(k) plans.

The measures will help Americans who are struggling and don’t have other cash stockpiles to support them in crisis, retirement experts said. But they said the rules also amount to another source of so-called “leakage” that run contrary to the overall goal of retirement savings: to build a nest egg for the future.

“I think it’s a theme you find in the [overall] retirement package: to allow retirement savings to be used for non-retirement purposes more easily,” said Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center

“It’s such a departure from the original notion of offering [tax] benefits for retirement, to make sure you have sufficient assets to get through those [later] years,” Rosenthal added.

The share of retirement savers who withdrew money from a 401(k) plan to cover a financial hardship hit a record high in October, according to data from Vanguard Group.

That dynamic — when coupled with other factors like fast-rising credit card balances and a declining personal savings rate — suggests households are having a tougher time making ends meet amid persistently high inflation and need ready cash, according to financial experts.

Nearly 0.5% of workers participating in a 401(k) plan took a new “hardship distribution” in October, according to Vanguard, which tracks 5 million savers. That’s the largest share since Vanguard began tracking the data in 2004.

Put another way, roughly 25,000 workers took one of these distributions.

Meanwhile, savers have been dipping into their nest eggs via other means — loans and “non-hardship” distributions — in higher numbers throughout 2022, according to Vanguard data.

“We are starting to see signs of financial distress at the household level,” Fiona Greig, global head of investor research and policy at Vanguard, previously told CNBC.

That said, the overall monthly share of people taking a hardship withdrawal is relatively small and not indicative of the “typical” 401(k) saver, she added.

Nearly all 401(k) plans allow workers to take hardship withdrawals, but employers may vary in their rationale for allowing them.

More than half of plans let workers tap funds to “alleviate major financial pressures,” according to the Plan Sponsor Council of America, a trade group. But they more frequently allow withdrawals to cover medical expenses, housing (to buy a primary residence, or prevent eviction or foreclosure), funeral costs or loss due to natural disasters, for example.

Participants can also access 401(k) savings via loans or non-hardship withdrawals. The latter are for workers over age 59½, and sometimes for workers in other circumstances not related to financial hardship (for instance, rolling over assets to an IRA while working).

Non-hardship distributions also hit an all-time high in October — almost 0.9% of participants took one that month, according to Vanguard. And the share of workers taking 401(k) loans rose to 0.9% in October from 0.8% at the beginning of 2022.