We study how rural households in Ethiopia adapt to droughts through labor reallocation. By using three waves of panel data and exploiting spatial-temporal variations in drought exposure, we find that households reduce on-farm work and increase off-farm self-employment in response to both short-term and persistent droughts, without abandoning family farming. Diversification into off-farm activities is driven by drought-related productivity declines in agriculture and contributes to consumption smoothing. Households with better access to markets and financial services find it easier to reallocate labor off-farm. Our results highlight the importance of strengthening the rural non-farm economy to enhance rural households’ climate resilience.