Retirement plan decisions made easy
Drill Down: Hardship Withdrawals
If you are 59½ years old, you can take money out of your 401k without penalty. You will still have to pay regular income tax on the distribution, but you will not be liable for any penalty.
If you are younger than 59½, there are a few reasons for which you can take a distribution without having to pay a penalty (though you are still accountable for the income tax). The permissible situations for withdrawing money early without a penalty include:
- Having unreimbursed medical expenses that are more than 7.5% of your adjusted gross income
- Medical insurance (The distributions cannot be more than the cost of your medical insurance)
- Being disabled
- Using the distributions to buy, build, or rebuild a first home
There are a few other possibilities; check with the Internal Revenue Service for the details.
In other cases, a hardship withdrawal will cost you both tax plus a ten percent penalty. To be eligible at all, your plan has to allow it. The plan may allow withdrawals for expenses considered immediate and heavy, including:
- Medical expenses
- Costs relating to the purchase of a principal residence
- Tuition and related fees
- Payments necessary to prevent eviction from, or foreclosure on, your home
- Burial or funeral expenses
- Certain expenses for the repair of damage to your home
Is This Your Best Solution?
Before I go on to describe all of the requirements you need to meet in order to take a hardship distribution withdrawal from your 401k, a discussion on the reasoning is in order. If you’re looking to tap into your retirement money (and thereby losing all of that growth advantage), you clearly must be facing some pressing needs. Is a hardship withdrawal the answer?
Assuming you meet all of the requirements below, it may be. But quite often, people investigate the possibility of making a 401k hardship withdrawal to pay off mounting credit card debt. As you’ll see below, that’s not even a permissible reason, and it most likely doesn’t address the real problem if the accumulated debts are due to bad habits.
If the debt is due to unwise spending habits, altering those habits would be far more helpful than a 401k withdrawal. Change your habits if you need to, and keep the money in your 401k. The actual cost to your retirement security is much greater than the amount you withdraw, for the total cost to you is what your money would have grown into by the time you retire had you let it be.
You don’t want to use a hardship withdrawal unless you absolutely must. Given a choice, you want to leave as much money in your 401k plan so that it can grow, tax deferred, to support you during retirement.
Requirements
If you determined that you still need to make a hardship withdrawal, check if your situation meets the following requirements laid out by the IRS—and yes, they are numerous. Your hardship disbursement request must:
- Constitute an immediate and heavy financial need
- Be necessary to satisfy that financial need (i.e. you can’t pay for it in some other way—perhaps with credit cards)
- Not exceed the amount that you actually need
- Follow exhaustion of all other distributions and nontaxable loans available through your 401k plan
- Not be followed by contributions to your 401k for 6 months following the withdrawal
Each individual’s plan will contain the exact requirements for making such a withdrawal, so make sure to check your specific plan. This sounds complicated, but it’s good to know that you have some options with your 401k when you need it. Just remember, if you’re under 59½, you will probably have to pay the 10% penalty tax for the early withdrawal, but you will not be required to repay the disbursement amount back to your 401k plan as you would with a loan.
Return to Lesson 5 ("Loans and Hardship Withdrawals from Your 401k")
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
Lesson 4: Investments: How Investments Work
» Lesson 5: Loans and Hardship Withdrawals from Your 401k
Lesson 9: Your 401k, Your Other Assets, and Your Life
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