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. These rules are important if you're younger than 59½ to avoid the 10% penalty for early withdrawals--or even to get the money at all, depending on the rules of your company's 401(k) plan. Once you hit that age you're permitted to withdraw funds from your 401(k) without penalty, whether you're suffering a hardship or not.

A hardship withdrawal allows funds to be withdrawn from your account to meet an “immediate and heavy financial need,” such as covering medical or burial expenses or avoiding foreclosure on a home. Without the hardship provision, withdrawals are difficult at best if you're younger than 59½.

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.

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.

Here's what you need to know about hardship withdrawals, beginning what you need to prove in order to qualify for one.

Key Takeaways

  • 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.

Eligibility for a Hardship Withdrawal

The Internal Revenue Service'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 itd. 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.

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. 

Excerpt from U.S. legislation describing a hardship withdrawal

Source: Congress.gov.

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.

Additional excerpt from legislation defining a hardship withdrawal with regards to cash or deferred arrangements

Source: Congress.gov.

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-paycheck years and losing the opportunity to use it then, and to have it continue to appreciate in the meantime. And you'll 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.

10%

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:

Also, note that 401(k) no-penalty withdrawal rules are slightly different from those for withdrawing money from a traditional IRA.

Other Ways to Get 401(k) Money

And account holders of any age may, if their employer permits it, have the ability to borrow money from a 401(k).

401(k) loans

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 that is returned to your account. 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. Note that if you leave your employer before the loan has been repaid, you generally have until October of the following year—the date income taxes with extensions are due—to repay the loan, under a rule change included in rules from the Tax Cuts and Jobs Act of 2017 (previously the window was generally 60 to 90 days).

401(k) loans must be repaid with interest in order to avoid penalties—but you pay that interest to your own account, not to a bank.

'In-service' withdrawals from your 401(k)

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.