For people who need money for urgent expenses and do not have the ability to pay them, one option is to consider a withdrawal of difficulties from their 401 (k) retirement account.
The 401 (k) plans of some employers, but not all, allow employees who have a balance in their plan to take advantage of 401 (k) cash as a withdrawal of hardship. Employees considering this should know that these special withdrawals are different from taking out a loan from your 401 (k). Retirement due to difficulties allows people in certain situations to receive a distribution from their retirement plan account while they are still working. But making a hardship withdrawal has a cost: hardship withdrawals are recorded as taxable income and an additional 10% penalty tax can also be applied. There is also the negative impact on your retirement savings that will never grow with deferred taxes for decades to come.
In general, hardship withdrawals can only be made if there is an immediate and strong financial need, the withdrawal is necessary and you cannot get the necessary money from any other reasonable source. Under IRS rules, withdrawals due to difficulties are only allowed for specific reasons, which include:
- Qualified medical expenses in excess of 10% of adjusted gross income
- Buying a primary residence
- Up to 12 months of qualified education expenses
- Funeral or burial expenses
- Home repair expenses due to accidents
- To prevent the eviction or foreclosure of a mortgage on a primary residence
While the reasons for taking retirement due to difficulty are serious, before you do so you should know that there are several drawbacks when it comes to retiring from a retirement plan:
- The amount distributed is taxed as ordinary income
- If you are under 59 and a half years old, an additional 10% penalty will be applied to the amount withdrawn
Another downside is that money considered retirement due to hardship cannot be refunded to your 401 (k) account, so this permanently reduces the balance of your retirement savings.
In addition, many employers require you to provide a written explanation of why you are requesting a withdrawal due to difficulties and why the need cannot be met with other reasonable resources. Disclosing these private details to your employer can be inconvenient.
The good news is that the new rules enacted last year make it easier to withdraw a larger amount from your account as a withdrawal due to difficulties.
According to the above rules, you could only withdraw the contributions you made to your account and not any of the corresponding money and investment income from the employer. In addition, when you make a withdrawal due to difficulties, you would be prohibited from making new contributions to the plan for six months, so you would lose any of your employer’s matching contributions during that time.
But according to the new rules, which went into effect in 2019 (and assuming the employer plan has been updated to allow for it), you can now withdraw contributions from your employers plus investment gains , in addition to your contributions. You can also continue to contribute, which means that you will not be so late in your retirement savings and you will still be able to receive the equivalent contributions from your company. You are also not required to take out a loan from the plan before making a withdrawal due to difficulties.
Remember that withdrawing from your employer’s retirement plan is really a last resort: the tax consequences are painful, the requirements are strict and cumbersome, and the reduction in your future retirement savings can be considerable. Also remember that while the IRS provides for employers to allow hardship withdrawals in their retirement plans, employers may choose not to offer them.
- In:
- 401k
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