Everyone knows they need a well-funded “rainy day” account to tap when something untoward happens. Think unemployment, a major car repair, medical setbacks. Yet most households find it difficult to accumulate precautionary savings. A new federal law designed to help cash-strapped households is now in effect, and it involves pulling money from retirement savings accounts.
People with traditional retirement savings accounts through their employer can quickly withdraw $1,000 in an emergency without penalty and fuss. Of course, simply because you can do it doesn’t mean you necessarily should. For more on the new rule and its tradeoffs, “Marketplace Morning Report” host David Brancaccio spoke with Chris Farrell, Marketplace’s senior economics contributor. The following is an edited transcript of their conversation.
David Brancaccio: So many people live paycheck to paycheck and don’t have the emergency fund if the transmission breaks or the hot water heater goes. But even people with retirement savings don’t have much of an emergency kitty. What are some of the numbers?
Chris Farrell: The personal savings rate fell from an average of 12% in the 1970s to less than 2% in the mid-2000s before rebounding to around 5% before the pandemic. The personal savings rate did soar during the COVID years. Households accumulated cash from various government programs while spending fell with so many businesses shuttered. The personal savings rate is now slightly below 4%. The Federal Reserve’s Survey of Household Economics and Decisionmaking shows that only 54% of adults have enough savings to cover three months of expenses if they lost their primary source of income.
Brancaccio: Enter the bipartisan legislation, the Secure Act 2.0. It became law in 2022. It’s about making it easier to save for retirement. But it had this little bit making it easier to take a little money out in an emergency.
Farrell: That’s right. Washington recognized that for many households, the largest savings pot is in their retirement plan. Although there are some exceptions, for most participants, you can’t touch retirement savings without paying a 10% penalty and income taxes on the amount withdrawn. The IRS has now finalized the Secure 2.0 rules for taking out up to $1,000 of your retirement money for any self-defined emergency. It’s worth mentioning that nearly half of all private-sector workers don’t have access to a retirement savings account through work. And of those who do, not everyone can afford to sock away much.
Brancaccio: But for those who could avail themselves of this in a squeeze, what are the rules?
Farrell: As you can imagine, there’s a lot of fine print here. But here’s the key: There is no early withdrawal penalty, and in essence you get to define what’s an emergency. You can only make one emergency withdrawal a year, and you can’t leave your retirement account with less than $1,000. You have three years after the withdrawal to put the money back into a retirement savings account. This way, you avoid paying income taxes on the withdrawal. You can’t take another emergency withdrawal unless you replenish retirement savings. You don’t have to pay the money back, but then you will owe taxes on the amount withdrawn. Perhaps most important, it’s up to employers to offer their employees the option.
Brancaccio: All right, so perhaps you want to lobby your employer on this. But, look, stepping back — I know emergencies are emergencies. But if you can tap one grand, is it a good idea?
Farrell: So, you know, David, to be a card-carrying personal finance expert, it always seems to be that you have to say, “Of course, you should never, ever tap that retirement savings account.” And, of course, it is best to let your retirement savings compound over the long haul. But I’m really glad the option now exists. Emergencies happen, and the big reason behind the lack of savings isn’t heedless shopping by consumers, but the long-term slowdown in household income growth. So the option will let some workers get themselves out of a tough financial spot quickly. And I think that’s for the better.
