Expanding Penalty Free Withdrawal Act
Expanding Penalty Free Withdrawal Act would broaden the existing penalty-free withdrawal rule under the Internal Revenue Code to include a new “long-term unemployment distributions” exception. Under the bill, individuals who have separated from employment and have received unemployment compensation for at least 26 consecutive weeks may take penalty-free distributions from retirement plans in the taxable year when unemployment compensation is paid or in the following year. The intent is to provide added liquidity to those facing prolonged joblessness, though the distributions would still be subject to ordinary income tax. The amount eligible for penalty-free withdrawal is capped by a combination of the total amount withdrawn in the prior year and the current value of the retirements accounts, as detailed below. The provision also clarifies coordination with existing rules for health-insurance premium distributions, so those amounts aren’t double-counted against the cap. The bill applies to distributions made after December 31, 2024 (i.e., starting in 2025). The bill was introduced in the House on January 9, 2025, by Representatives Watson Coleman (with colleagues Cherfilus-McCormick and Norton) and referred to the Ways and Means Committee.
Key Points
- 1New exception: Adds “long-term unemployment distributions” to the penalty-free distribution options under 72(t)(2) for retirement plans.
- 2Eligibility: After separation from employment, the individual must have received unemployment compensation for 26 consecutive weeks under federal or state law (or the maximum period allowed by state law), and distributions must occur in the year unemployment compensation is paid or the following year.
- 3Reemployment/self-employment: For individuals who reenter employment or become self-employed, rules will follow the conditions outlined for related distributions in the existing D subparagraph (health-insurance premium distributions), with similar guardrails.
- 4Annual cap: The eligible penalty-free withdrawal is limited to the lesser of:
- 5- (I) $50,000, reduced by the total amount of such distributions taken from all plans in the 1-year period ending the day before the distribution; or
- 6- (II) the greater of $10,000 or one-half of the aggregate fair market value of the individual’s qualified retirement plans (and the nonforfeitable portion of defined-contribution plans).
- 7Coordination with health-insurance distributions: Distributions used to pay health-insurance premiums under the existing provision (subparagraph D) are not counted toward this new cap.
- 8Tax treatment: The bill changes the penalty tax (the 10% early-withdrawal penalty) but does not specify changes to ordinary income tax treatment; distributions under this provision would generally remain subject to regular income tax.
- 9Effective date: Applies to distributions made after December 31, 2024 (i.e., 2025 and later).