New tax rules provide flexibility in dealing with life's 'curveballs'

Sometimes life doesn't go as planned. Cars break down, basements flood, people get sick, couples get divorced. Starting in 2024, new IRS rules make it a little easier to use retirement accounts to deal with the challenges life sometimes throws at us. So let's talk about when the government allows retirement savers to use money held in IRAs or company-sponsored retirement plans (aka 401(k) or 403(b)) before retirement age.

First, I know that some TV and radio "financial advisors" act like taking an early withdrawal from a retirement plan is akin to chopping one's foot off. And in general, retirement plans are not designed or intended to be slush funds for discretionary spending. I, however, provide financial advice in the real world, to real people and families, and I know sometimes life throws us curveballs.

I have also come to realize that we Americans don't always save money in what I would consider from a planning point of view an "ideal" sequence or order. Over the past 40 years, the retirement planning industry has done a good job of educating the public and stressing the importance of saving for retirement. This public messaging, combined with incentives like employer 401(k) matching contributions and automatic enrollment, has resulted in many young families being what I would call "retirement plan poor."

It is not uncommon for my team to meet younger families (those under 40) who have zero money in savings, are struggling with credit card or student loan debt, have no money saved for college expenses, but have hundreds of thousands of dollars in a 401(k). These families often feel like they are "doing what they should be doing," and yet are over stressed by personal finances and money concerns.

From personal and professional experience, I have come to feel strongly that a family balance sheet is best built from the base up. The base being a designated emergency fund, then six months of expenses saved in the bank, and then begin accumulating retirement savings. Despite the ideal, when working with investors we work with the cards we've been dealt -- and some new IRS rules will make it easier to use IRAs and employer-sponsored plans to swing at some of life's curveballs.

Starting in 2024, retirement account owners can now take a hardship withdrawal of up to $1,000 per year without incurring the 10% pre-59½ early withdrawal tax penalty. My understanding is the hardship will be self-certified and is defined as an "unforeseeable or immediate financial needs relating to a personal or family emergency." The new rules also allow -- but do not require -- the hardship withdrawal to be repaid to the retirement plan over the subsequent three years. While no repayment is required, no additional hardship withdrawals can be taken until the funds are paid back or three years have passed.

In addition to the basic hardship withdrawal outlined above, the new rules also permit tax-penalty-free withdrawals of up to $10,000 or 50% of an IRA or employer-sponsored plan's account value by individuals who are the victim of domestic abuse. This provision enables this type of hardship withdrawal for up to one year after the abuse incident, and also permits repayment of the withdrawal over the next three years.

While utilizing funds held in a retirement plan for pre-retirement hardship is certainly not ideal, I think these new rules do a nice job of recognizing that many American families are heavily invested in retirement and yet not well positioned to deal with shorter-term emergency needs. Knowing that in some situations retirement funds could be used to help deal with life's challenges is a positive, in my opinion -- though I strongly encourage anyone considering these types of transactions to get professional tax and financial advice first.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.