Pre-Retirement Withdrawals from Your 401(k)

Hardship Withdrawals

A hardship withdrawal is available in many 401(k) plans. A hardship withdrawal allows you to withdraw pre-tax money from your account if you have a "financial hardship." This means you must have an immediate and heavy financial need that cannot be met by any other means. Hardship withdrawals are strictly defined by the IRS. Even though plans can adopt their own standards for hardships, most plans follow the IRS definition of hardship withdrawals.

Plans using this IRS definition require you to take other measures before the 401(k) plan will permit you to take a hardship withdrawal.

Under the IRS rules, there are two types of hardship withdrawal methods that can be incorporated into a plan: a safe harbor method and a facts and circumstances method.

Safe Harbor Method

Under the safe harbor method, you are subject to several rules.

First, before your hardship withdrawal request will be considered, you must have taken the maximum amount of loans permitted under the 401(k) plan rules and permitted by your 401(k) plan account balance. You must have also received all the after-tax contribution withdrawals you could receive under the rules of the 401(k) plan.

Second, you may withdraw only the amount necessary to meet the hardship needs and to pay the taxes on the withdrawal. You may withdraw only from your rollover or pre-tax contributions. You may withdraw earnings on those contributions, but the amount is limited. Your 401(k) plan administrator or human resource department can advise you on the amount eligible to be withdrawn.

Third, hardship withdrawals will only be permitted for the following needs:

  1. Significant un-reimbursed medical expenses for yourself and/or your dependents.
  2. The purchase (excluding mortgage payments) of your principal residence.
  3. Prevention of foreclosure on or eviction from your principal home.
  4. Tuition and related fees for the next 12 months of post-secondary education for yourself and/or your dependents.
  5. Your funeral expenses, as well as for your spouse, children, dependents, or beneficiary.
  6. Certain expenses to repair damage to your principal residence.

IMPORTANT NOTE: If your plan follows the safe harbor rules for hardship withdrawals, you are subject to the six-month suspension rule. This means you can't begin contributing to the 401(k) again until after the six month suspension has passed.

Facts and Circumstances Method

Under the facts and circumstances method, the employer must determine whether an immediate and heavy financial need exists based on all relevant facts and circumstances.

Which Method Is Best?

The advantage to the safe harbor method is that your employer won't have to pry into and police your personal financial situation. The disadvantage is that it offers less flexibility and subjects a participant to the six-month suspension rule.

Consequences of a Hardship Withdrawal

Hardship withdrawals should be avoided if at all possible. Hardship withdrawals have three BIG disadvantages:

  1. You pay income taxes on the money you withdraw.
  2. You pay a 10% early withdrawal penalty, unless you are over age 59½ (or after age 55 if you have separated from service) or the withdrawal was made to pay medical expenses.
  3. Most plans will not permit you to make contributions to the 401(k) plan for at least six months after you receive the withdrawal, if you use the safe harbor method.

This last item is particularly harmful to your retirement savings plan. You will have lost six months of retirement saving opportunity.

IMPORTANT NOTE: Hardship withdrawals cannot be rolled over to an IRA.

IMPORTANT NOTE: We recommend that you do not take a hardship withdrawal but instead find other ways to obtain the money you need.

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