| TYPE OF WITHDRAWAL | 10% PENALTY? |
|---|---|
| Medical expenses | No (if expenses exceed 10% of AGI) |
| Permanent disability | No |
| Substantial equal periodic payments (SEPP) | No |
| Separation of service | No |
| Purchase of principal residence | Yes |
| Tuition and educational expenses | Yes |
| Prevention of eviction or foreclosure | Yes |
| Burial or funeral expenses | Yes |
A 401(k) hardship withdrawal isn't the same as a 401(k) loan. There are a number of differences, the most notable one being that hardship withdrawals usually do not allow money to be paid back into the account. You will be able to keep contributing new funds to the account, however.
The Bipartisan Budget Act of 2018 made it easier in some ways to take hardship withdrawal from a 401(k) or 403(b) plan. For example, it eliminated the requirement to take a plan loan before you become eligible for a hardship distribution.
Although a hardship withdrawal might be eligible to avoid the 10% penalty, it still incurs income taxes on the sum you withdraw.
How to Make a 401(k) Hardship Withdrawal
To make a 401(k) hardship withdrawal, you will need to contact your employer and plan administrator and request the withdrawal. The administrator will likely require you to provide evidence of the hardship, such as medical bills or a notice of eviction. The administrator will also review your request to ensure it meets the criteria for a hardship withdrawal. If the request is approved, the administrator will process the withdrawal and release the funds to you.
It is important to carefully review the terms of your 401(k) plan and consult with your plan administrator to understand the process for making a hardship withdrawal and any potential consequences. Additionally, it is generally advisable to exhaust other options, such as an emergency fund or outside investments, before considering a hardship withdrawal from your 401(k) plan.
The conditions under which hardship withdrawals can be made from a 401(k) plan are determined by the provisions in the plan document—as elected by the employer. For example, whether or not you will be allowed to take a hardship distribution is a decision that still remains with your employer. Your employermay also limit the uses of such distributions, such as for medical orfuneral costs, as well as require documentation. Speak to a human resources representative at your workplace to find out the specifics of the plan.
You may want to ask the plan administrator or the employer for a copy of the summary plan description (SPD). The SPD will include information about when and under what circ*mstances withdrawals can be made from your 401(k) account. You can also ask to be provided with an explanation in writing.
Paying Medical Bills
Plan participants can draw on their 401(k) balance to pay for medical expenses that their health insurance does not cover. If the unreimbursed bills exceed 10% of your adjusted gross income (AGI), the 10% tax penalty is waived.
To avoid the fee, the hardship withdrawal must take place in the same year that you received medical treatment.
Thanks to the passage of the SECURE 2.0 Act of 2022, starting Jan. 1, 2024 plan participants will be able towithdraw $1,000 a year for emergency personal or family expenses without paying the 10% penalty.
Living With a Disability
If you become “totally and permanently” disabled, getting access to your retirement account early becomes easier. In this case, the government allows you to withdraw funds before age 59½ without penalty. Be prepared to prove that you’re truly unable to work. Disability payments from either Social Security or an insurance carrier usually suffice, though a doctor's confirmation of your disability is frequently required.
Keep in mind that if you are permanently disabled, you may need your 401(k) even more than most investors. Therefore, tapping your account should be a last resort, even if you lose the ability to work.
Penalties for Home and Tuition Withdrawals
Under U.S. tax law, there are several other scenarios where an employer has a right, but not an obligation, to allow hardship withdrawals. These include the purchase of a principal residence, payment of tuition and other educational expenses, prevention of an eviction or foreclosure, and funeral costs.
However, in each of these situations, even if the employer does allow the withdrawal, the 401(k) participant who hasn't reached age 59½will be stuck with a sizable 10% penalty on top of paying ordinary taxes on any income. Generally, you’ll want to exhaust all other options before taking that kind of hit.
In the case of education, student loans can be a better option, especially if they're subsidized.
SEPPs When You Leave an Employer
If you’ve left your employer, the IRS allows you to receive substantially equal periodic payments (SEPPs) penalty-free—although they're technically not hardship distributions. One important caveat is that you make these regular withdrawals for at least five years or until you reach 59½, whichever is longer. That means that if you started receiving payments at age 58, you’d have to continue doing so until you hit 63.
As such, this isn’t an ideal strategy for meeting a short-term financial need. If you cancel the payments before five years, all penalties that were previously waived will then be due to the IRS.
There are three different methods you can choose for calculating the value of your withdrawals:
- Fixed amortization, a fixed schedule of payment
- Fixed annuitization, a sum based on annuity or life expectancy
- Required minimum distribution (RMD), based on the account's fair market value
Atrusted financial advisor can help you determine which method is most appropriate for your needs. Regardless of which method you use, you’re responsible for paying taxes on any income, whether interest or capital gains, in the year of the withdrawal.
Separation of Service
Those who retired or lost their job in the year they turned 55 or later have yet another way to pull money from their employer-sponsored plan. Under a provision known as “separation from service,” you can take an early distribution without worrying about a penalty. However, as with other withdrawals, you’ll have to be sure you can pay the income taxes.
Of course, if you have a Roth version of the 401(k), you won't owe taxes because you contributed to the plan with post-tax dollars.
Another Option: A 401(k) Loan
If your employer offers 401(k) loans—which differ from hardship withdrawals—borrowing from your own assets may be a better way to go. Under IRS 401(k) loan guidelines, savers can take out up to 50% of their vested balance, or up to $50,000 (whichever is less). One of the advantages of a loan is that the plan participant isn’t forced to pay income taxes on it that same year, nor does it incur that early withdrawal penalty.
Be aware, however, that you have to repay the loan, along with interest, within five years (unless the funds are used to purchase a home—in the case you'll have longer). If you and your employer part ways, you have until October of the following year—the ultimate deadline (with extension)for filing tax returns—to repay the loan.
Do You Have to Pay Back a Hardship Withdrawal from a 401(k)?
Qualified hardship withdrawals from a 401(k) cannot be repaid. However, you must pay any deferred taxes due on the amount of the withdrawal. You may also be subject to an early withdrawal penalty if the hardship withdrawal is not deemed qualified or if you withdraw more than needed to exactly cover the specific hardship.
What Proof Do You Need for a Hardship Withdrawal?
You must provide adequate documentation as proof for your hardship withdrawal. Depending on the circ*mstance, this can include invoices from a funeral home or university, insurance or hospital bills, bank statements, and escrow payments. These are necessary for tax purposes, and you don't usually have to disclose these to your employer or plan sponsor.
How Long Does It Take Until I Receive Funds from a Hardship Withdrawal?
A hardship withdrawal will usually take seven to 10 business days, which also includes the time needed to review your withdrawal application.
What Are Hardship Withdrawal Limits?
The IRS sets general guidelines for hardship withdrawals, but the specific limits and conditions are determined by the provisions in each individual 401(k) plan. In general, a 401(k) hardship withdrawal allows you to access your salary deferral contributions (the amounts withheld from paychecks) and, in some cases, the employer's matching contributions. The exact amount that can be withdrawn will depend on the plan's rules. For example, some plans may limit the amount that can be withdrawn or require the individual to take a loan from the plan before becoming eligible for a hardship withdrawal.
The Bottom Line
If you absolutely need to use your retirement savings before age 59½, 401(k) loans are ordinarily the first method to pursue. But if borrowing isn’t an option—not every plan allows it—a hardship withdrawal may be a possibility for those who understand the implications. One big downside is that you can't pay the withdrawn money back into your plan, which can permanently hurt your retirement savings. As such, a hardship withdrawal should only be done as a last resort.
Examine your workplace 401(k) plan, and take note of which situations would be subject to a 10% penalty and which won't. This may make the difference between a smart method of getting cash or a smashing blow to your retirement nest egg.
