Law Opens New Doors for Penalty-Free Retirement Account Distributions

This post may contain affiliate links which may compensate us based on your interaction. Please read the disclosures for more information.

A 10% penalty applies to non-qualified withdrawals. 

For many, withdrawing from a retirement account early could come with a sizable penalty. However, the SECURE Act 2.0, signed into law in December, expands permitted withdrawals from retirement accounts, and could save some account holders thousands of dollars in penalties.

Victim relief

Under current law, a non-qualified distribution from a retirement account, such as a withdrawal made prior to age 59 ½, carries a hefty penalty. In addition to being taxed on the full amount of the distribution, you could be responsible for a 10% penalty. The IRS provides a variety of exceptions to the penalty, but prior to the SECURE Act 2.0, offered little by way of exceptions to victims of extenuating circumstances.

One of the more celebrated provisions of the legislation provides for an exception to the distribution penalty for victims of domestic abuse. Starting on Jan. 1, 2024, self-certifying victims will be eligible to withdraw the lesser of $10,000 or half of their retirement account balance to escape an unsafe situation. The withdrawal will not be subject to a penalty, and may be repaid within three years.

Victims of federally declared disasters are also afforded more flexibility when accessing their retirement funds. Affected Americans can withdraw up to $22,000 from their qualified plan or Individual Retirement Account, and employers can increase the amount that participants can borrow from their plan. In addition to being penalty-free, the distribution will be counted as taxable income over a period of three years. The provision applies retroactively to disasters declared on or after Jan. 26, 2021.

Terminal illness

For the millions of Americans suffering from a terminal illness, funding short-term treatments and end-of-life care is of critical importance. Prior to the SECURE Act 2.0, however, many of these individuals would be subject to a penalty in order to access their retirement savings. The new law made some significant changes.

Following the passage of the legislation late last year, distributions made from retirement accounts to those with a terminal illness are exempt from the 10% penalty. The law will help those suffering from a terminal illness, and their families, make the most of their savings.

Long-term care

Today, an American celebrating their 65th birthday has a nearly 70% chance of needing long-term care in the future. Coupled with the fact that the average long-term care stay lasts three years and costs over $80,000 on average, it makes sense that products like long-term care insurance are becoming increasingly popular.

Planning for long-term care insurance often starts many decades before a long-term care stay is needed. For middle-aged Americans, however, affording long-term care insurance premiums can be difficult, especially when much of your wealth is tied up in your retirement plan. Starting in late 2025, Americans will be able to use their retirement accounts to pay for up to $2,500 of annual long-term care insurance premiums — all without incurring a 10% penalty.

Retirement accounts are difficult to tap into by design. However, the restrictive nature of retirement saving may punish those who save for their future but have an emergency in the short term. The SECURE Act 2.0 broadens exceptions to the retirement withdrawal penalty, offering a lifeline to victims of domestic abuse, natural disasters, and terminal illnesses. The legislation also serves to help Americans plan for future hazards, such as a long-term care need.

Our best stock brokers

We pored over the data and user reviews to find the select rare picks that landed a spot on our list of the best stock brokers. Some of these best-in-class picks pack in valuable perks, including $0 stock and ETF commissions. Get started and review our best stock brokers.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

 Read More