If you need a significant sum of money and don't expect to have the means to repay it, one option that may be available is a hardship withdrawal from the 401(k) at your current employer. Without the hardship provision, withdrawals are difficult at best if you're younger than 59½. A hardship withdrawal, though, allows funds to be withdrawn from your account to meet an “immediate and heavy financial need,” such as covering medical or burial expenses or avoiding foreclosure on a home.
But before you prepare to tap your retirement savings in this way, check that you're allowed to do so. Employers don't have to offer hardship withdrawals, or the two other ways to get money from your 401(k)—loans and non-hardship in-service withdrawals.
- A hardship withdrawal from a 401(k) retirement account can help you come up with much-needed funds in a pinch.
- Unlike a 401(k) loan, the funds to do not need to be repaid. But you must pay taxes on the amount of the withdrawal.
- A hardship withdrawal can give you retirement funds penalty-free, but only for certain specific qualified expenses such as crippling medical bills or the presence of a disability.
Even if your employer offers the measure, you should be cautious about using it. Financial advisors typically counsel against raiding your retirement savings except as an absolute last resort. Indeed, with new rules now in place that make hardship withdrawals easier, some advisors fear a run on retirement funds at the expense of using options that are less damaging to long-term financial health.
Below, we'll discuss what you need to know about hardship withdrawals, beginning with what you need to prove in order to qualify for one.
Eligibility for a Hardship Withdrawal
The Internal Revenue Service (IRS)'s “immediate and heavy financial need” stipulation for a hardship withdrawal applies not only to the employee's situation. Such a withdrawal can also be made to accommodate the need of a spouse, dependent, or beneficiary.
Immediate and heavy expenses include the following:
- Certain medical expenses
- Home-buying expenses for a principal residence
- Up to 12 months’ worth of tuition and fees
- Expenses to prevent being foreclosed on or evicted
- Burial or funeral expenses
- Certain expenses to repair casualty losses to a principal residence (such as losses from fires, earthquakes, or floods)
You won’t qualify for a hardship withdrawal if you have other assets that you could draw on to meet the need or insurance that will cover the need. However, you needn't necessarily have taken a loan from your plan before you can file for a hardship withdrawal. That requirement was eliminated in the reforms, which were part of the Bipartisan Budget Act passed in 2018.
The $2-trillion coronavirus emergency stimulus bill signed into law on March 27, 2020, allows those affected by the coronavirus situation a hardship distribution to $100,000 without the 10% penalty those younger than 59½ normally owe; account owners have three years to pay the tax owed on withdrawals, instead of owing it in the current year.
Nothing in the reforms, however, makes it any more certain that you can take a hardship distribution. That decision is still up to your employer. “A retirement plan may, but is not required to, provide for hardship distributions,” the IRS states. If the plan does allow such distributions, it must specify the criteria that define a hardship, such as paying for medical or funeral expenses. Your employer will ask for certain information and possibly documentation of your hardship.
How Much You Can Withdraw
You can’t just withdraw as much as you want; it must be the amount “necessary to satisfy the financial need.” That sum can, however, include what’s required to pay taxes and penalties on the withdrawal.
The recent reforms allow the maximum withdrawal to represent a larger proportion of your 401(k) or 403(b) plan. Under the old rules, you could only withdraw your own salary-deferral contributions—the amounts you had withheld from your paycheck—from your plan when taking a hardship withdrawal. Also, taking a hardship withdrawal meant you couldn't make new contributions to your plan for the next six months.
Under the new rules, you may, if your employer allows it, be able to withdraw your employer’s contributions plus any investment earnings in addition to your salary-deferral contributions. You’ll also be able to keep contributing, which means you’ll lose less ground on saving for retirement and still be eligible to receive your employer’s matching contributions.
Some might argue that the ability to withdraw not just salary-deferral contributions but also employer contributions and investment returns is not an improvement to the program. Here’s why.
What Hardship Withdrawals Will Cost You
Hardship withdrawals hurt you in the long run when it comes to saving for retirement. You're removing money you've set aside for your post-pay-check years and losing the opportunity to use it then, and to have it continue to appreciate in the meantime. You'll also be liable for paying income tax on the amount of the withdrawal—and at your current rate, which may well be higher than you'd have paid if the funds were withdrawn in retirement.
If you are younger than 59½, it's also very likely you'll be charged at 10% penalty on the amount you withdraw.
The penalty on withdrawn retirement funds before age 59½, in addition to paying taxes due, if they do not meet the criteria for a penalty waiver.
If you're in that age group, you'll be subject to the 10% penalty unless you're receiving the funds under any of the following circumstances:
- A corrective distribution. This is money repaid to you as a highly compensated employee deemed to have contributed too much to a 401(k) compared to other employees; income tax is owed on this money
- Total and permanent disability
- A qualified domestic relations order, issued as part of a divorce decree)
- IRS levies on the plan
- A series of substantially equal periodic payments
- A dividend pass-through from an Employee Stock Ownership Plan
- Medical expenses in excess of 10% of adjusted gross income (AGI)
- Employee separation from service after age 55
- Certain distributions to qualified military reservists called to active duty
Also, note that 401(k) no-penalty withdrawal rules are slightly different from those for withdrawing from a traditional IRA.
Other Options for Getting 401(k) Money
If you're at least 59½, you're permitted to withdraw funds from your 401(k) without penalty, whether you're suffering from hardship or not. And account-holders of any age may, if their employer permits it, have the ability to loan money from a 401(k).
Most advisors do not recommend borrowing from your 401(k) either, in large part because such loans also threaten the nest egg you've accumulated for your retirement. But a loan might be worth considering in lieu of a withdrawal if you believe there's a chance you'll be able to repay the loan in a timely way (with most 401(k)s, that means within five years).
Loans are generally permitted for the lesser of half your 401(k) balance or $50,000 and must be repaid with interest, although both the principal and interest payments are made to your own retirement account. It is also worth noting that the CARES Act raises the borrowing limit from $50,000 to $100,000. If you should default on the payments, the loan converts to a withdrawal, with most of the same consequences as if it had originated as one.
401(k) loans must be repaid with interest in order to avoid penalties.
About two-thirds of 401(k)s also permit non-hardship in-service withdrawals. This option, however, does not immediately provide funds for a pressing need. Rather, the withdrawal is allowed in order to transfer funds to another investment option.
You might, however, consult a tax or financial advisor to explore whether this option might be able to serve your needs. Indeed, engaging professional advice to help explore your options is wise if you're considering a hardship withdrawal or any other move to obtain funds immediately.