How to Take 401(k) Hardship Withdrawals | 401ks

If you’re looking for resources to get through a difficult financial situation, you may have considered taking money out of your 401(k) plan. There are several circumstances when current employees can take 401(k) withdrawals, but you’ll need to meet certain criteria to avoid penalties when withdrawing funds early from your retirement account.

To understand how to take 401(k) hardship withdrawals, consider the following:

A hardship withdrawal refers to accessing funds in a retirement account before you reach the eligible age for withdrawals. 401(k) plans are typically set up to allow withdrawals starting at age 59 1/2. Individuals who take distributions before that age usually have to pay a 10% penalty and income tax on the amount withdrawn. However, for those facing hardship, some plans allow participants to take an early withdrawal. If certain requirements are met, you could avoid paying the 10% penalty.

The Internal Revenue Service allows a 401(k) hardship withdrawal if you have an “immediate and heavy financial need.” In these situations, the 10% penalty could be waived. According to the IRS, the following as situations might qualify for a 401(k) hardship withdrawal:

Before making a withdrawal, check if your 401(k) plan provides the option of 401(k) hardship withdrawals. Not all plans permit you to take a hardship withdrawal.

“It’s up to the plan sponsor to decide whether to allow hardship withdrawals,” said Kyle Ryan, executive vice president of sales and advisory services at Empower Personal Wealth in Danville, California, in an email. If your account provider permits you to take out funds, you’ll have to show that you don’t have other available funds to cover the expenses.

A qualifying financial need doesn’t have to be unexpected. An expense may be considered immediate and heavy even if it is an event you had knowledge of or voluntarily pursued. But many costs will not be determined to be immediate and heavy. A consumer purchase, such as a boat or television, would not usually be viewed as a qualifying factor for a hardship distribution.

For those who meet the criteria to qualify for a 401(k) hardship withdrawal, the next step is to determine the amount you can take out. In most cases, you’ll be allowed to withdraw only what you need. For example, if it will cost $10,000 to fix your house after an earthquake, you won’t be able to take out more than that. You may be allowed to take additional funds to help cover related costs, such as taxes to be paid on the transaction.

When taking a hardship withdrawal, the funds will be subject to income tax, and you may also need to pay a 10% early withdrawal penalty if you are under age 59 1/2 years. You won’t be able to repay the plan or roll over the funds into another account like an IRA.

To receive the funds, you will need to talk to your plan sponsor, who might be a human resources representative at your workplace or a financial advisor assigned to the plan.

“This is generally where the employee can find out about the employer’s specific requirement and obtain the paperwork necessary to begin the hardship withdrawal,” Stivers said. “Generally speaking, the paperwork necessary to apply for a withdrawal will either be by paper or online.”

If you remove funds from a 401(k) for a hardship and spend them, you lose out on the amount saved and the additional interest that could have accumulated in the account for retirement.

“Every dollar withdrawn from your 401(k) early is a dollar that isn’t there for retirement,” Ryan said. “In addition, you lose the opportunity for these funds to grow on a tax-deferred basis over the long term, which could potentially grow your nest egg even more.”

Among the reasons for taking a hardship withdrawal, using funds to help purchase a home where you will live may have the least negative impact. “A home does appreciate over time much like an investment,” said Ben Barzideh, a wealth advisor at Piershale Financial Group in Barrington, Illinois, in an email. “There are also emotional and psychological benefits to owning a home.”

Money held within a qualified retirement plan is typically protected from creditors, but when you withdraw funds from a 401(k), they could become subject to claims. If you’re thinking of filing for personal bankruptcy or will be unable to make payments for an extended time, you may decide to keep your funds in the 401(k).

Rather than a withdrawal, it might be possible to take a 401(k) loan. In most cases, the loan will be limited to a certain amount, and you’ll need to pay it back over a specific period, which is usually less than five years, along with interest. If you leave your job before paying off the loan, the balance will be considered a withdrawal and become subject to income taxes and also a penalty if you are not yet 59 1/2 years old.

If you’re over age 59 1/2, you might be able to take distributions from your 401(k) account without any penalties. And for early retirees, the IRS allows penalty-free distributions for those 55 or older who have left the workforce. The age is lowered to 50 for retired public safety professionals, such as police officers and firefighters.