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401(k) Hardship Withdrawals

401(k) is a type of retirement savings account that’s usually available through employers. However, what happens if a life event occurs and you need access to those funds? In this case, a 401(k) hardship withdrawal, or hardship distribution, could help you get around some IRS penalties. While they can be useful for getting out of a jam, there are consequences, such as tax implications. A financial advisor can be a beneficial resource if you need to withdraw money from your 401(k).

Are You Eligible for a 401(k) Hardship Withdrawal?

The IRS permits hardship withdrawals for the following reasons:

  • Pay certain medical bills for you, your spouse or your dependents
  • Avoid foreclosure on or buy a primary residence
  • Cover educational expenses for you, your spouse or your dependents
  • Pay for family funeral expenses
  • Pay for certain kinds of home repairs, such as those necessary after a natural disaster

Some employers’ plans limit qualifying hardships further. In general, you’ll have an easier time qualifying for hardship withdrawals for medical and funeral expenses than for other types of bills. It’s easier to make a case for paying off an existing obligation than for a 401(k) hardship withdrawal for a home purchase.

When you take hardship withdrawals from your 401(k), you’ll need to prove to the IRS that you don’t have other resources at your disposal, and that you’re not taking more than you need. In other words, you cannot utilize this tax workaround if you want to take a vacation to the Caribbean with your family.

Even if you meet the requirements for a hardship withdrawal, make sure it’s definitely the right decision for you. They come with real consequences, so make them your absolute last resort.

How Much Can You Withdraw From Your 401(k)?

401(k) Hardship Withdrawals

The money that’s in your 401(k) is comprised of your contributions, the investment earnings on them and any matching contributions from your employer. The IRS divides your overall 401(k) account balance into these three categories.

The cap on what you’re allowed to withdraw is the amount that you’ve contributed yourself. Depending on your company’s specific 401(k) plan, you may be able to withdraw some matched funds too. However, you cannot withdraw earnings on your money.

Disadvantages of 401(k) Hardship Withdrawals

Making the move on a 401(k) hardship withdrawal can set your retirement savings back a bit. In fact, once you take a hardship withdrawal from your 401(k), you cannot contribute to the account for six months. So even if your finances turn around quickly, you’ll have to wait before resuming contributions to your employer-sponsored retirement plan.

Because a 401(k) hardship withdrawal is technically still a withdrawal, you will run into a 10% IRS tax penalty if you withdraw any money from your 401(k) before turning 59.5 years old. Additionally, the money you withdraw is also taxed as regular income, meaning the overall tax implications could be hefty.

Hardship Withdrawals vs. 401(k) Loans

Taking a hardship withdrawal from your 401(k) is an alternative to taking a 401(k) loan. While you won’t have to pay the money back when you take a hardship withdrawal, the aforementioned 10% IRS tax penalty will apply. Remember that this is in addition to your standard income tax rate, meaning the IRS will hit you hard come tax time.

The flip side is that a 401(k) loan is just that: a loan. Just like any other form of debt, you’ll need to pay it back, in this case, to your own account. Failure to make on-time payments will result in not only a default, but a 10% withdrawal penalty as well. That’s because the IRS will consequently view your loan as income if you don’t pay it back. Should this happen, you’ll essentially incur the disadvantages of both hardship withdrawals and 401(k) loans.

Eligibility for a hardship withdrawal is dependent upon whether or not you meet the requirements above. On the other hand, your purpose for needing a 401(k) loan is completely irrelevant in the eyes of the IRS. So as long as you can pay the money back on time, you won’t run into trouble.

Bottom Line

401(k) Hardship Withdrawals

If you’re looking into hardship withdrawals, chances are you’re in dire need of some extra money. However, once you finally resume making contributions, you’ll realize how tough it is to make up for lost time. That’s why it’s a good idea to leave your 401(k) alone if at all possible. To ensure that you’re proceeding with the decision best suited for your financial future, feel free to reach out to a financial advisor.

Retirement Planning Tips

  • Although a viable option, 401(k) hardship withdawals aren’t the most ideal. Instead, perhaps a financial advisor can help you find another way out of a financial struggle without having to tap into your hard-earned retirement money. SmartAsset’s free advisor matching tool makes your search for a new advisor much easier. In 5 minutes, it will set you up with as many as three suitable advisors in your area. Get started now.
  • Social Security can be a valuable supplement to your existing retirement funds. If you’re unsure about how much money you’re in line to receive, check out SmartAsset’s Social Security calculator. All you need to know is your annual income and the age at which you’re planning to start receiving benefits.
  • If you want to handle your retirement plans on your own, make sure you’re not flying blind. SmartAsset’s retirement calculator makes figuring out exactly how much you’ll need to save for your desired retirement lifestyle much simpler.

Photo credit: ©iStock.com/nevarpp, ©iStock.com/cyano66, ©iStock.com/fizkes

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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