Hardship Withdrawals from Employer-Sponsored Retirement Plans
Hardship withdrawals are a type of “discretionary” distribution available from certain employer-sponsored retirement plans. Retirement plans aren’t required to allow employees to take hardship withdrawals while they are still working for the employer. Consult your plan administrator or your employer’s benefits department to find out if hardship withdrawals are available from your plan. If your plan allows this type of withdrawal, to qualify you’ll need to clearly demonstrate a financial hardship (as defined below) to justify the withdrawal.
Eligibility requirements for a hardship withdrawal
So, what exactly qualifies as a hardship withdrawal? In a 401(k) plan, you can withdraw your own elective contributions (pre-tax and Roth) if you have an “immediate and heavy financial need,” and other resources aren’t reasonably available to you to meet that need. You must have already utilized all other available distributions and nontaxable loans under all plans maintained by your employer. You can withdraw only the amount necessary to satisfy your financial need.
Qualifying reasons for a hardship withdrawal from a 401(k) plan include the need to:
- Pay medical bills for you, your spouse, your children, your other dependents, or your plan beneficiary
- Pay costs directly related to the purchase of a principal residence for yourself (excluding mortgage payments)
- Pay post-secondary tuition for you, your spouse, your children, your other dependents, or your plan beneficiary
- Prevent an eviction from or foreclosure of your principal residence
- Pay funeral expenses for a parent, your spouse, your children, your other dependents, or your plan beneficiary
- Repair damage to your principal residence after certain casualty losses
- Pay income tax and/or penalties due on the hardship withdrawal itself
Check with your plan administrator about qualifying financial needs. In addition, be aware that not all of your plan account can be utilized for this purpose. For hardship withdrawal purposes, you can generally only withdraw an amount equal to your own elective contributions less any prior hardship withdrawals. (In limited circumstances, you may also be able to withdraw the earnings on your elective contributions—again, check with your plan administrator.)
Caution: Similar hardship rules apply to Section 403(b) plans. Somewhat different rules apply to Section 457(b) plans, nonqualified deferred compensation plans, and to hardship withdrawals of employer contributions.
Caution: Defined benefit and money purchase pension plans can’t permit hardship withdrawals.
Advantages of taking a hardship withdrawal
If you are in a difficult financial situation and have nowhere else to turn, a hardship withdrawal may be your only source of available funds.
Disadvantages of taking a hardship withdrawal
A hardship withdrawal is generally treated as a taxable distribution to you and, if you aren’t age 59½ or older, the 10 percent federal premature distribution tax (and perhaps a state penalty) may also apply (certain exceptions are available). See “Income tax consequences of a hardship withdrawal” below.
When you take a hardship distribution of your elective contributions from a 401(k) plan, you generally can’t make an additional elective contribution (salary-reduction or Roth) or after-tax contribution to your 401(k) plan, or to any other deferred compensation plan maintained by your employer (qualified and nonqualified) for a minimum of six months after the hardship withdrawal is taken, depending on the specific provisions of your plan.
The funds you withdraw from your plan account are no longer part of your tax-deferred retirement plan. This hardship withdrawal will reduce the size of your plan balance, and the funds you withdraw will miss out on further tax-deferred growth in the plan. This means that a large hardship withdrawal could jeopardize your ability to reach your retirement goals.
Caution: You can’t roll over hardship withdrawals.
How hardship withdrawals differ from plan loans
If you are eligible to take a loan from your retirement plan, there is generally an easy qualification process (in fact, qualification is often automatic). With a hardship withdrawal, though, you must establish that you have an immediate and heavy financial need, and meet the specific requirements set out in your employer’s plan. Some plans don’t permit hardship withdrawals (or loans) at all.
Plan loans have to be repaid to avoid income tax and possible penalties on the amount borrowed. A hardship withdrawal is generally subject to federal (and possibly state) income tax for the year in which you receive the distribution. In addition, the distribution may be subject to a 10 percent federal penalty (and perhaps a state penalty) if you are under age 59½. You are generally not permitted to repay a hardship withdrawal to avoid taxes and/or penalties on it.
How to get a hardship withdrawal
There are five main steps that you must follow to take a hardship withdrawal:
- Determine how much money you need, and whether there is any other reasonable source available to meet your need.
- Check with your plan administrator to find out if your plan allows hardship withdrawals, the requirements to qualify for such a withdrawal, and the maximum amount you can withdraw.
- Request a hardship withdrawal from your plan administrator. The procedure varies from plan to plan, so check with your plan administrator on how to apply for a hardship withdrawal from your plan.
- Get your spouse’s consent, if necessary. Ask your plan administrator if your spouse’s consent is required for you to take a hardship withdrawal from your plan.
- Pay any income tax and/or penalties due on the hardship withdrawal. You will typically do this when you file your federal and state income tax returns for the year of the withdrawal.
Income tax consequences of a hardship withdrawal
As discussed, a hardship withdrawal is generally treated as taxable income to you for federal (and possibly state) income tax purposes. In addition, if you aren’t at least age 59½, the 10 percent federal premature distribution tax (and perhaps a state penalty) may apply (certain exceptions are available). The tax consequences of a hardship withdrawal from a Roth 401(k) or Roth 403(b) account depend on whether your distribution is qualified or nonqualified. Before taking a hardship withdrawal, it’s best to consult a tax advisor regarding the income tax implications.