You Can Now Withdraw $1K From Your 401(k) Penalty-Free — but You Still Shouldn’t

As of the beginning of this year, the Secure Act 2.0 allows Americans to withdraw up to $1,000 from tax-advantaged retirement accounts to pay for “unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses” without having to worry about an early withdrawal penalty.

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While this can serve as a financial lifeline, some financial experts caution against tapping into your retirement savings to cover emergencies. Here’s why you may want to think twice before making a withdrawal from your long-term savings .

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The Downsides to Making an Emergency Withdrawal From Your Retirement Fund

If you need money ASAP, making an emergency withdrawal from your retirement savings might seem like a no-brainer.

“A hardship withdrawal can give you immediate access to the money you need without having to worry about paying it back,” said Mindy Yu, director of investing at Betterment . “This can be a lifesaver if you’re facing urgent, dreadful financial challenges, like unexpected medical bills or the threat of foreclosure on your home. However, an emergency withdrawal from your retirement savings can have several downsides and long-term impacts.”

It’s important to keep these downsides in mind before taking out any funds.

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Reduced Retirement Funds

“The most immediate impact is a decrease in your retirement nest egg, reducing the amount of money available when you retire,” Yu said.

Delayed Retirement

If you rely on these withdrawals too often, you may not be able to retire when you want to.

“Reduced funds may result in having to work longer to compensate for the shortfall,” Yu said.

Missed Earnings Potential

Money in your retirement savings account compounds over time, so when you withdraw funds, you also miss out on that money’s future earnings.

“Emergency withdrawals can disrupt the time your money is invested in the market, affecting long-term savings goals,” Yu said.

“Because of these reasons, careful consideration and exploring other financial avenues are crucial ahead of deciding to withdraw from your retirement savings,” she noted.

Alternatives to Tapping Into Your Retirement Savings

The best way to pay for an emergency is with an emergency fund. Ideally, you can set aside three to six months’ worth of living expenses, but every little bit counts.

“While this may be a luxury to some, careful planning can help even those with the tightest of budgets to set aside money for unforeseen expenses, such as unemployment, critical illness or accidents,” Yu said.

If you don’t have an emergency fund, there are other alternatives to consider before tapping into your retirement savings. One is to seek out an interest-free financing option.

“Say your furnace needs to be replaced — oftentimes there are options to finance the purchase of a new furnace without paying interest as long as you make the minimum payment every month,” said Jennifer Stein, CFP, former director of client engagement at Priebe Wealth.

If you’re paying for a medical emergency, see if you can set up a payment plan with your provider.

“Discuss payment options with your hospital’s billing department, and see if a payment plan is an option for paying down the expense,” Stein said.

Another option is to use a credit card with a 0% intro APR.

“Credit cards are not something I would generally recommend people start carrying a balance on, but in an emergency, it may be what works best,” said Wayne Brown, chief visionary officer at Dugan Brown .

Finally, you might consider taking out a personal loan, particularly if you qualify for a low interest rate.

What To Do If You Make a Hardship Withdrawal From Your Retirement Account

If you must make a hardship withdrawal from your retirement account, it’s important to take steps to quickly replenish the amount you took out.

“By setting aside a few dollars every paycheck — perhaps even through an automated transfer from your checking account — you can slowly build [back your] fund,” Yu said.

In addition to these regular contributions, Yu recommended increasing your contributions when your budget allows. This could be when you receive a promotion or bonus. She also recommended catch-up contributions.

“If you’re eligible, make catch-up contributions allowed for those over 50,” Yu said.

She also recommended looking for ways to find extra money to set aside in your retirement account.

“Reevaluate your budget to find areas where you can cut expenses and redirect that money to your retirement fund,” Yu said. “It is worthwhile cutting back on discretionary spending while you build this fund and treat it as your No. 1 priority.”

This article originally appeared on GOBankingRates.com : You Can Now Withdraw $1K From Your 401(k) Penalty-Free — but You Still Shouldn’t