Your IRA Might Soon Be Able to Double as Your Emergency Fund. Here's Why

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  • Tapping an IRA before age 59 ½ can result in costly penalties.
  • Lawmakers are looking at one key change that could give savers penalty-free access to their retirement funds for emergency withdrawals of $1,000.
  • It's still a good idea to have a separate emergency fund, so you can keep your retirement savings in place for when you'll need them in the future.

New rules are being introduced that could give savers more flexibility with their retirement savings.

There's a reason workers are encouraged to save for both emergencies and retirement. In the case of the former, you never know when life might throw you a curveball. And without a chunk of cash in your savings account, you might land in debt if you have an unplanned expense.

Meanwhile, you need retirement savings because Social Security most likely won't pay you a high enough monthly benefit to cover your living costs in full. And without a nest egg, you might struggle financially as a senior.

Now many people who save for retirement opt to do so in tax-advantaged accounts. With a traditional IRA account or 401(k) plan, you get a tax break on the funds you contribute. You also get to enjoy tax-deferred growth in your account, whereas with a regular brokerage account, you're on the hook for capital gains taxes every year.

But on the flip side, IRAs and 401(k)s bind you to certain rules. One of them is that you're not allowed to take withdrawals prior to age 59 1/2. Doing so will typically result in a 10% early withdrawal penalty, unless you happen to qualify for an exception. And unfortunately, withdrawals to cover emergency expenses don't get you out of being assessed that penalty.

Lawmakers may be looking to change that, though. And if a new set of rules passes, you may be able to take a penalty-free IRA withdrawal if an unplanned bill pops up and you don't have enough money in your savings account to cover it.

The rules could change

This week, lawmakers are looking to pass a $1.7 trillion spending bill, and part of that package is a set of new retirement rules known as Secure 2.0. One provision within Secure 2.0 is the option for savers to take an emergency withdrawal of up to $1,000 from an IRA or 401(k) without being hit with a penalty.

Now, on the one hand, that $1,000 limit may be restrictive in situations where a large bill pops up out of the blue. But still, the option to access $1,000 penalty-free is better than not having penalty-free access for emergency withdrawals at all. So if Secure 2.0 passes as part of that larger bill, savers should get more flexibility in the near future.

You still need an emergency fund

If Secure 2.0 becomes law, you'll have more options for raiding your IRA or 401(k) in a pinch. But it's still a good idea to build yourself a separate emergency fund.

For one thing, a $1,000 withdrawal may not go very far if you're looking at, say, a $10,000 home repair bill. And also, the whole point of funding an IRA is to have money available during retirement. So you don't want to keep tapping your savings prematurely, because if you do, you could end up with a shortfall on your hands once your career wraps up.

But still, giving workers limited penalty-free access to retirement savings for emergency withdrawals is a positive thing. And if this change becomes official, it could spare a lot of people a world of expensive debt.

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