401k Hardship Withdrawals - An Overview
A 401k retirement plan may, but is not required to, provide for hardship distributions. Again, most plans do, but some don't. Check with your Human Resources department if you're not sure if your plan allows hardship withdrawal.
Like a 401k loan, your employer must adhere to some very strict and detailed guidelines.
The IRS code that governs 401k plans provides for hardship withdrawals only if: (1) the withdrawal is due to an immediate and heavy financial need; (2) the withdrawal must be necessary to satisfy that need (i.e. you have no other funds or way to meet the need); (3) the withdrawal must not exceed the amount needed by you; (4) you must have first obtained all distribution or nontaxable loans available under the 401k plan; and (5) you can't contribute to the 401k plan for six months following the withdrawal.
Under the provisions of the Pension Protection Act of 2006, the need of the employee also may include the need of the employee's non-spouse, non-dependent beneficiary.
The following items are considered by the IRS as acceptable reasons for a hardship withdrawal:
- Unreimbursed medical expenses for you, your spouse, or dependents.
- Purchase of an employee's principal residence.
- Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
- Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
- For funeral expenses.
- Certain expenses for the repair of damage to the employee's principal residence.*
Hardship withdrawals are subject to income tax and, if you are not at least 59½ years of age, the 10% withdrawal penalty. You do not have to pay the withdrawal amount back.
A hardship distribution may not exceed the amount of the need. However, the amount required to satisfy the financial need may include amounts necessary to pay any taxes or penalties that may result from the distribution.
A Couple of Other Notes
The rules for hardship distributions from 403(b) plans are similar to those for hardship distributions from 401k plans.
The hardship rules are only relevant while you still work for the sponsor of your 401k. Once you are separated from service (through permanent layoff, termination, quitting or retirement), the hardship rules do not apply.
* Certain Expenses for the Repair of Damage to the Employee's Principal Residence
Repairs to a principal residence must fall under the IRS's description of a casualty loss in order to qualify for a hardship withdrawal. The damage must be from an event that is sudden, unexpected, or unusual. Damages resulting from progressive deterioration of your residence due to normal wear and tear, normal weather conditions, or a pest infestation are not considered casualty losses.
Casualty losses can result from a number of causes, including the following examples: earthquakes, fires, floods, vandalism, and storms, including hurricanes and tornadoes. Some examples paraphrased from IRS Publication 547 (www.irs.gov/pub/irs-pdf/p547.pdf) that illustrates what would be considered a casualty loss and what would not:
Example 1: The deterioration of a water heater that burst is not considered a casualty loss; however the resulting damage to the home due to the water would be considered a casualty loss.
Example 2: The damage or destruction of trees, shrubs, or other plants by a fungus, disease, insects, worms, or similar pests is not considered a casualty loss. However, a sudden destruction due to an unexpected or unusual infestation of insects may result in a casualty loss.
Example 3: The steady weakening of a building due to normal wind and weather conditions is not considered a casualty loss. However, damage done by hurricane winds may result in a casualty loss.
Hardship Withdrawals Give Access to Your 401k Savings, But at a Cost
Emergency Access to Your 401k: Hardship Withdrawals
Don't Tap Your 401k to Pay Off Debt
Do's and Don'ts of Hardship Distributions
IRS FAQs Regarding Hardship Distributions
Hardship Distributions and Compliance
The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.