A 401k hardship withdrawal can be a lifesaver in times of financial emergency, but it's essential to understand the rules and implications before taking the plunge. You can withdraw up to $10,000 in a 12-month period, but be aware that this will reduce your future retirement savings.
The IRS allows 401k hardship withdrawals for six specific reasons: buying a primary residence, paying for medical expenses, paying for funeral expenses, paying for qualified education expenses, preventing foreclosure or eviction, and repairing damage to a primary residence.
These reasons are carefully defined to ensure the withdrawal is only for a legitimate emergency.
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What Is a 401k Hardship Withdrawal?
A 401k hardship withdrawal is a way to access your retirement savings before age 59 1/2, but it's not a loan or a withdrawal in the classical sense. You can take a hardship withdrawal from your 401k to pay for certain expenses, such as buying a primary residence, paying for funeral expenses, or preventing foreclosure.
To be eligible for a 401k hardship withdrawal, you must have a qualified financial need, which can include things like paying for medical expenses, tuition, or a down payment on a primary residence. These expenses must be unavoidable and you must be able to prove that you have no other means of paying for them.
A 401k hardship withdrawal is taxed as ordinary income, and you'll also have to pay a 10% penalty, unless you're 55 or older and separating from your employer. This can be a significant tax hit, so it's essential to consider other options before tapping into your retirement savings.
You can only take a hardship withdrawal from your 401k once, and you'll typically have to repay the withdrawn amount within three years to avoid paying taxes and penalties.
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How It Works
To get approved for a 401(k) hardship withdrawal, you'll need to contact your employer's benefits department. They'll guide you through the process, which varies by plan.
Your employer determines what qualifies as an immediate and heavy financial need, and you may be asked to prove you can't pay for the expense using your income, savings, nonretirement investments, or insurance.
You can only withdraw the amount necessary to cover your financial need, plus enough for income taxes on the withdrawal. Certain plans will allow you to remove the principal contributions made to the plan; others may allow for withdrawals of both contributions and earnings.
Here are the 2 main qualifying rules for a 401(k) hardship withdrawal:
- You’re facing an immediate and heavy financial need.
- You can withdraw only the amount necessary to cover your financial need.
Eligibility and Requirements
To be eligible for a 401(k) hardship withdrawal, you don't necessarily have to have taken a loan from your plan, as this requirement was eliminated in 2018 reforms.
You can make a hardship withdrawal for yourself, your spouse, or your dependents, and in some cases, for a primary beneficiary. Hardship withdrawals are designed to help you cover certain financial hardships, such as medical expenses, home-buying expenses, or funeral expenses.
The IRS has a broad definition of hardship, and hardship withdrawals are currently allowed for one of the following reasons: medical expenses, home-buying expenses, preventing foreclosure or eviction, funeral expenses, tuition and related expenses, or expenses to repair damage to your primary residence.
Here are the specific reasons that qualify as a hardship withdrawal:
- Certain expenses to repair casualty losses to a principal residence (such as losses from fires, earthquakes, or floods)
- Expenses to prevent being foreclosed on or evicted
- Home-buying expenses for a principal residence
- Up to 12 months’ worth of tuition and fees
- Burial or funeral expenses
- Certain medical expenses
What Qualifies as?
A hardship withdrawal from your 401(k) plan is only possible if you're facing certain financial hardships. These hardships can be quite broad, allowing you to withdraw money from your retirement plan for a variety of reasons.
To qualify for a hardship withdrawal, you'll need to meet specific criteria set by the IRS. According to the IRS, hardship withdrawals are allowed for one of the following reasons:
- Medical expenses incurred by the participant or the participant’s spouse, dependents or beneficiaries.
- The purchase of a home if the home will serve as a primary residence, not an investment property.
- To prevent eviction from or foreclosure on a primary residence.
- Funeral expenses for the participant or the participant’s spouse, dependents or beneficiaries.
- Tuition and related expenses (such as fees and room and board) for the next year of post-secondary education for the participant or the participant’s spouse, dependents or beneficiaries.
- Expenses that are necessary to repair damage to the participant’s primary residence that would qualify for a casualty deduction.
In addition to these reasons, you may also be able to withdraw money from your 401(k) if you're facing certain expenses related to a casualty loss, such as a fire, earthquake, or flood. Your employer or plan sponsor will ask for specific information and possibly documentation of your hardship before approving your withdrawal.
Time Requirements
A hardship withdrawal can take 7-10 business days, which includes a review of your withdrawal application.
You'll need to be patient during this time as the process is subject to review and verification.
The review process typically takes a few business days, after which you can expect to receive a decision on your application.
It's a good idea to plan ahead and allow for this timeframe when considering a hardship withdrawal.
Tax Implications
You'll have to pay income taxes on a 401(k) hardship withdrawal. This is a mandatory tax, and your 401(k) plan administrator will withhold 20% of the amount requested.
You may end up owing more in taxes depending on your income level. This is because the 20% withheld might not cover the full amount of taxes you'll need to pay.
The Internal Revenue Service (IRS) allows you to withdraw enough money to cover both the cost of your financial need and the income taxes on your withdrawal. This can help you avoid taking out too much money and incurring unnecessary tax liabilities.
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A 401(k) hardship withdrawal is a taxable event, and you'll need to pay taxes on the withdrawn amount. The IRS has specific rules and exceptions for hardship distributions, which you can find in the IRS publications listed below.
Here are some key tax implications to keep in mind:
Alternatives and Considerations
Before taking a 401(k) hardship withdrawal, consider using your emergency fund – that's what it's there for.
You can also tap into a Roth IRA, where you can withdraw funds that equal what you contributed (the principal) without penalty.
A home equity line of credit (HELOC) might be worth exploring, but use your home equity with caution.
If taking a 401(k) hardship withdrawal is your only option, you'll have potentially no debt in the face of an emergency expense.
You won't have to repay what you removed, unlike a 401(k) loan.
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Special Cases
You can take a hardship withdrawal from your 401k to cover expenses related to hurricanes and natural disasters. The IRS has added a new safe harbor expense to the list of eligible expenses, which includes costs incurred as a result of certain disasters.
This new safe harbor expense is similar to relief given by the IRS after major federally declared disasters, such as Hurricane Maria and California wildfires.
You can find more information on disaster area relief in Publication 547, Casualties, Disasters, and Thefts, and in the IRS's section on Tax relief in disaster situations.
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Financial Aspects
Hardship withdrawals from a 401(k) can be a costly mistake, as they'll hurt your ability to save for retirement. You'll not only be removing money set aside for your post-paycheck years, but also losing the interest that money would have earned over time.
You'll be liable for paying income tax on the withdrawal amount and will have to pay it at your current rate, which may be higher than if the funds were withdrawn in retirement. This can result in a significant tax bill.
If you're under 59½, you may be subject to the 10% penalty, though some exceptions apply. Here are some of the exceptions to the penalty:
- A corrective distribution, or money repaid to you as a highly compensated employee deemed to have contributed too much to a 401(k) compared to other employees
- Certain distributions to qualified military reservists called to active duty
- Qualified birth or adoption expenses
- Death of the account owner
- Disaster recovery after a federally-declared disaster
- Domestic abuse
- Qualified higher education expenses
- Terminal illness
- A qualified domestic relations order, issued as part of a divorce decree
- Medical expenses in excess of 10% of adjusted gross income (AGI)
- A dividend pass-through from an Employee Stock Ownership Plan
- A series of substantially equal periodic payments
- Employee separation from service after age 55
- Total and permanent disability
- IRS levies on the plan
Amounts
You'll need to withdraw only the amount necessary to satisfy your financial need from your 401(k) or 403(b) plan. This amount can include what's required to pay taxes and penalties on the withdrawal.
Hardship withdrawals can represent a larger proportion of your 401(k) or 403(b) plan compared to other types of withdrawals. If your employer allows it, you may withdraw its contributions plus any investment earnings in addition to your salary-deferral contributions.
You can keep contributing to your 401(k) or 403(b) plan after a hardship withdrawal, which means you'll lose less ground on saving for retirement. This is a significant advantage over other types of withdrawals.
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Cost
Taking a 401(k) withdrawal can have significant costs. You'll have to pay income tax on the withdrawal amount at your current rate, which may be higher than if the funds were withdrawn in retirement.
The 10% penalty applies if you're under 59½, but there are some exceptions. These include situations like a corrective distribution, qualified military reservist distributions, and qualified birth or adoption expenses.
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Some exceptions to the 10% penalty are quite specific, like a qualified domestic relations order issued as part of a divorce decree. Others are more general, such as medical expenses in excess of 10% of your adjusted gross income.
You won't have to prove hardship to take a withdrawal, but it's a good idea to keep documentation of the reason for the withdrawal. This can be useful in case of an audit or other issues.
Here are some of the exceptions to the 10% penalty:
- Corrective distribution
- Certain distributions to qualified military reservists called to active duty
- Qualified birth or adoption expenses
- Death of the account owner
- Disaster recovery after a federally-declared disaster
- Domestic abuse
- Qualified higher education expenses
- Terminal illness
- Qualified domestic relations order
- Medical expenses in excess of 10% of adjusted gross income (AGI)
- Dividend pass-through from an Employee Stock Ownership Plan
- Series of substantially equal periodic payments
- Employee separation from service after age 55
- Total and permanent disability
- IRS levies on the plan
Frequently Asked Questions
What proof do you need for hardship withdrawal?
To qualify for a hardship withdrawal, you'll typically need to provide documentation of your financial hardship, such as medical bills, college invoices, or bank statements showing insufficient funds. This proof ensures you're eligible for the withdrawal and helps the IRS verify your claim.
What are some hardship reasons?
Life events such as job loss, illness, divorce, and family death can qualify as hardship reasons. These significant life changes may impact your financial situation and eligibility for certain benefits.
Do 401k hardship withdrawals have to be paid back?
No, hardship distributions from a 401k plan are not repaid to the plan and permanently reduce the account balance. This is a key difference from loans, which must be repaid with interest.
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