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. While current employees can take 401(k) withdrawals in several circumstances, 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:
— What is a 401(k) hardship withdrawal?
— Reasons for a 401(k) hardship withdrawal
— 401(k) hardship withdrawal limits and taxes
— 401(k) hardship withdrawal self-certification
— Consequences of taking a 401(k) hardship withdrawal
— Alternatives to a 401(k) hardship withdrawal
[Read: When a Retirement Hardship Withdrawal Makes Sense]
What Is a 401(k) Hardship Withdrawal?
A 401(k) hardship withdrawal allows you to access funds in your retirement account before you reach the eligible age for withdrawals if you have an immediate and heavy financial need. The amount you can withdraw generally cannot exceed the amount necessary to cover the emergency.
Most 401(k) plans allow participants to begin taking withdrawals at age 59 1/2. Individuals who take distributions before that age generally must pay income tax on the amount withdrawn and may also owe a 10% additional tax. However, those facing financial hardship may be able to take an early withdrawal from a plan that allows hardship distributions. Depending on the circumstances, certain requirements may allow you to avoid the 10% additional tax.
Not all 401(k) plans allow hardship withdrawals. “It’s up to the plan sponsor to decide whether to allow hardship withdrawals,” said Kyle Ryan, senior vice president of digital sales at wealth management firm Mariner in the San Francisco Bay area, in an email. Your plan may have additional requirements for taking a hardship distribution, so it’s important to understand the rules before making a withdrawal.
If your plan does, check your plan documents or contact your plan administrator to find out when you can take a hardship withdraw and what requirements you must meet. Some plans also allow participants to take an emergency personal expense distribution of up to $1,000 per calendar year for unforeseen personal or family emergencies.
Reasons for a 401(k) Hardship Withdrawal
The Internal Revenue Service defines a 401(k) hardship distribution as a withdrawal made because of an “immediate and heavy financial need.” The distribution must be limited to the amount necessary to satisfy that financial need.
A qualifying financial need doesn’t have to be unexpected. An expense may be considered an immediate and heavy financial need even if it was reasonably foreseeable or voluntarily incurred.
Under the IRS hardship distribution safe harbor rules, certain expenses are automatically considered to meet the immediate and heavy financial need requirement. They include:
— Certain medical expenses for you, your spouse, dependents or primary beneficiary
— Burial or funeral costs
— Costs related to purchasing a principal residence
— College tuition and education fees for the next 12 months
— Expenses required to avoid a foreclosure or eviction
— Expenses related to fixing major property damage to your primary property that qualifies for a casualty-loss deduction
— Expenses resulting from a federally declared disaster when your principal residence or place of employment was in an area designated for individual assistance
Employers determine whether to offer hardship withdrawals and the specific requirements participants must meet under the plan. “Some employers require that an employee exhaust a loan privilege before applying for a hardship withdrawal,” said Brian Stivers, president and founder of Stivers Wealth Management in Knoxville, Tennessee, in an email.
[Read: Guaranteed Income Strategies for Retirement]
401(k) Hardship Withdrawal Limits and Taxes
If you qualify for a 401(k) hardship withdrawal, the amount you can take generally is limited to what is necessary to meet your immediate and heavy financial need. For example, if it will cost $10,000 to repair your home after an earthquake, you generally can’t withdraw more than the amount needed to cover the expense. However, you may be able to withdraw additional funds to cover the taxes and penalties that result from the distribution.
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.
Unlike a plan loan, a hardship distribution cannot be repaid to the 401(k) plan. It also generally cannot be rolled over to another retirement account, such as an IRA.
401(k) Hardship Withdrawal Self-Certification
Under IRS rules, an employee can submit a written self-certification when requesting a hardship distribution. This certification could indicate the following:
— The distribution is being requested for an immediate and heavy financial need that qualifies under the hardship rules.
— The amount requested is not more than the amount needed.
— The participant has no alternative means of satisfying the financial need, or has insufficient cash or other liquid assets available to do so.
The certification can generally be provided in writing or electronically. Each plan has its set of procedures, and you’ll want to keep documents related to the expense and withdrawal in case they are needed later.
To request a distribution, contact your plan administrator or human resources department and ask about the plan’s specific hardship withdrawal procedures, along with the documentation or certification requirements.
Consequences of Taking a 401(k) Hardship Withdrawal
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, founding partner and wealth manager at Barzideh & Nadeau Wealth Management 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).
[Read: 401(k) Hardship Withdrawals Are at Record Highs: What They Really Cost You]
Alternatives to a 401(k) Hardship Withdrawal
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 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.
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How to Take 401(k) Hardship Withdrawals originally appeared on usnews.com
Update 08/25/26: This story was published at an earlier date and has been updated with new information.
