If you find yourself in dire need of money, don’t want to take on credit card or other debt, and have a 401k plan through your employer, you might be able to request a 401k hardship withdrawal. A 401k hardship withdrawal can only be used for certain financial needs and emergencies, according to the rules of your 401k and the IRS. Find out what situations qualify you to make a 401k hardship withdrawal and how you can make one, if you must.
What is a 401k hardship withdrawal?
If you’re under the age of 59.5 and still work for the same employer offering the 401k plan, you might be allowed to take a 401k hardship withdrawal for certain immediate and heavy financial needs. Those needs can include the needs of the employee’s spouse and dependent, and can also include a non-spouse and non-dependent.
Your employer is not required to provide access to a 401k hardship withdrawal, but most do. Approximately 88 percent of 401k plans have options for hardship withdrawals, according to the Society for Human Resources Management. Unlike a loan, which is paid back with interest just like a loan to any other institution, a 401k hardship withdrawal cannot be paid back.
If your 401k plan allows for a hardship withdrawal, you must have taken all other distributions from the same employer’s plan and non-taxable loans first. You can only draw the amount needed for the immediate and heavy financial need, and the amount cannot exceed the amount of your total elective contributions, including designated Roth IRA contributions.
IRS-Approved Reasons for a Hardship Withdrawal
A 401k hardship withdrawal can only be made for reasons allowed by the IRS. According to the IRS, the following are allowable reasons to take a 401k hardship withdrawal:
- Certain medical expenses that will not be covered by insurance for you, your dependent or a beneficiary of your 401k plan
- Costs related to the purchase of a principal residence — not including vacation homes, vehicles or luxury items
- College tuition and other education-related costs and fees for you, your spouse or your dependent
- Payments to prevent eviction from or foreclosure on a principal residence on which the employee or spouse is listed on the rental agreement or note
- Burial or funeral expenses for spouse, dependent or beneficiaries on the 401k plan that will not be covered by insurance
- Certain expenses for the repair of damage to the principal residence that will not be covered by insurance
According to SHRM, the rules regarding the reasons for a 401k hardship withdrawal can be a little murky. For medical, education and funeral expenses, the rules have been interpreted to include hardships incurred by a named beneficiary under the plan, but the individual must be the primary beneficiary at the time that the hardship occurred, according to SHRM. Participants are not allowed to change the beneficiary designation after the hardship.
How to Make a 401k Hardship Withdrawal
If you find yourself in an IRS-approved situation and think you want to make a 401k hardship withdrawal, you must follow the process outlined by your 401k provider and your employer. Although the exact process and requirements will vary with each 401k provider and each company, there are a few general steps involved with any 401k hardship withdrawal:
- Investigate all other avenues before seeking a 401k hardship withdrawal. Figure out if you have liquid assets that you can use toward your financial situation.
- If you are still working for the same employer and are under 59.5 years old, find out if your 401K plan allows for hardship withdrawal. Some plans offer options for a hardship loan, but not a hardship withdrawal.
- Contact your human resources advisor to find out what paperwork is required.
- Provide your HR advisor with the necessary paperwork and documentation.
- Wait for the paperwork to be processed and for your 401k hardship withdrawal to be approved.
Note that when applying for a 401k hardship withdrawal, the required paperwork and documentation varies by situation. Required documents could include:
- Medical bills
- Invoices for educational expenses
- Notice of eviction or foreclosure
- Death notice
- Bills pertaining to damage repairs on your home
Know the True Cost of a 401k Hardship Withdrawal Before Taking One
A 401k hardship withdrawal can save you from certain financial catastrophes. But this type of withdrawal can be costly in terms of the loss of accrued interest earned over time. Aside from that, a 401k hardship withdrawal is also costly because it’s subject to taxes — 20 percent of which are typically taken up-front — and a 10-percent penalty.
Due to these taxes, possible penalties and missed opportunity to accrue interest in the account, a 401k hardship withdrawal should be your last resort, considered only in times of extreme financial difficulty. Before you decide to make an early withdrawal from your 401k, consider consulting with a financial advisor or a tax attorney to figure out what is best for your situation.