401k Hardship Withdrawal Rules & Distribution Facts

Have you found yourself in a pinch financially and need access to cash? A 401k hardship withdrawal may be an option for you and hardship distributions aren’t just for 401k plans! In fact many plans which allow elective contributions (such as 403(b) plans and 457(b) plans) allow for hardship withdrawals. But just what is a hardship withdrawal?

 

What is a 401k hardship withdrawal?

A 401k hardship withdrawal is most simply defined by the IRS as “an immediate and heavy financial need”. The IRS also states that “the amount must be necessary to satisfy the financial need.” Presumably should you need $10,000 for medical bills and only have $5,000 in your 401k plan, a hardship withdrawal would not work since it doesn’t satisfy the financial need. Conversely if you need $10,000 you CANNOT withdraw more than that amount.

The IRS determined the financial need can be that for the 401k participant, their spouse, or dependent children. Interestingly enough under the Pension Protection Act of 2006 the financial need may also be from the employee’s non-spouse, non-dependent beneficiary. So essentially anyone who is listed as a beneficiary on your 401k plan in addition to your spouse and dependent children may have a financial need which would qualify.

 

How does a financial need qualify as being immediate and heavy?

This is a pretty grey statement the IRS put forth, however they went on to qualify it a bit more as follows:

  • Certain medical expenses
  • Costs associated with purchasing your primary residence
  • Tuition and educational fees and expenses
  • Payments necessary to prevent eviction or foreclosure on your primary residence
  • Burial/funeral expenses
  • Damage repair expenses on your primary residence

It’s important to note that the need might not be immediate and heavy if you had a reasonable amount of time to prepare for it or it was voluntarily incurred. It’s also important to note if you have other financial resources you’re expected to use those to handle your financial needs first. This even includes the assets of your spouse or children.

Not every plan allows for every potential type of hardship distribution. Some plans will allow for medical expenses yet not for purchasing a primary residence for example. You’ll need to consult with your plan document to find out what it allows for specifically.

To qualify for a 401k hardship withdrawal you must have exhausted all other distribution options under the plan. If you have loans available, you’re expected to tap those first. Many 401k plans which allow loans only allow one at a time however, and many other plans don’t allow loan features at all! Keep in mind you’ll be prohibited from making elective contributions to your 401k plan for at least 6 months after receiving the hardship distribution.

 

How do you prove you have a financial emergency?

To prove you qualify for a 401k hardship withdrawal you’ll need to work with your plan administrator. In some cases they may just take your word for it, in other cases they’ll ask you for more specific information (an eviction notice, medical bills, etc.). Most 401k plans use the “deemed necessary” rules so they don’t have too dig deep into the participants financial status. The safe bet would be to thoroughly document the financial need and amount, as well as every step you’ve taken to reach that need without doing a hardship distribution and why the distribution is the last available option.

 

What are the tax consequences of a 401k hardship distribution?

All distributions from pre-tax contribution amounts are included in ordinary income. Amounts taken from designated Roth contributions are not included in ordinary income unless the Roth deferral is less than 5 years old and you’re under age 59 and 1/2. If you don’t meet the 5 year and over age 59 and 1/2 minimum, a pro-rata share of the Roth earnings will be included in your gross income. On top of the income tax due a penalty of 10% of the amount will apply if you haven’t reached age 59 and 1/2.