Life’s path has a way of taking unexpected detours. When facing difficulties, particularly of the financial sort, it’s important to understand your options and not make rash decisions under pressure. If you find yourself in need of money on short notice, you should consider all of your options, which can include tapping your personal savings, borrowing money, or, as a last resort, dipping into retirement savings. Typically, money in your employer-sponsored retirement plan is accessed by taking what’s known as a hardship withdrawal.
What’s a hardship withdrawal?
Hardship withdrawals are an optional type of distribution you can take from some employer-sponsored retirement plans, such as 401(k)s, 403(b)s, and 457 plans. Typically, you can’t take money out of these types of plans without paying a penalty unless you turn 59½ (except for a 457 plan, which doesn’t have this age requirement), leave your employer, or retire. However, a hardship withdrawal allows you to take money out of your plan in certain extenuating circumstances.
Note that your plan isn’t required to allow hardship withdrawals. So talk with your plan administrator or your employer’s benefits department to find out if they’re available to you.
What qualifies as a hardship withdrawal?
In a traditional or Roth 401(k) plan, you can withdraw your own elective contributions if you, your spouse, your dependents, or your plan beneficiary have an “immediate and heavy financial need.” Your elective contributions are the money you personally put in — not any employer match or profit-sharing.
Whether you have an immediate and heavy financial need can vary by situation. However, the Internal Revenue Service provides guidance about situations that generally qualify:
- Expenses to repair major damage to your primary home after certain catastrophes, like a natural disaster.
- Certain medical bills for you, your spouse, children, other dependents, or your plan beneficiary.
- Costs directly related to buying a primary home for yourself (note that this does NOT include mortgage payments).
- Post-secondary tuition for you, your spouse, children, other dependents, or your plan beneficiary.
- Payments needed to prevent eviction from or foreclosure on your primary home.
- Burial and funeral expenses for a parent, spouse, child, other dependents, or your plan beneficiary.
- Income taxes and/or penalties you owe on the hardship withdrawal itself.
Check with your employer to see if they have any additional requirements or restrictions. Some plans won’t let you take a hardship unless you’ve already taken all other available distributions and nontaxable loans from your plan. They may also restrict you from making any new contributions to the plan for six months or more after taking a hardship withdrawal. In addition to a 401(k) plan, your employer can also provide information on the special rules for 457(b) and other nonqualified deferred compensation plans that you participate in.
How much can I take in my hardship withdrawal?
In a 401(k) plan, the amount available for hardship withdrawal is generally equal to the sum of your personal contributions, minus any prior hardship withdrawals. Some plans may also let you withdraw your employer’s regular matching contributions and profit-sharing contributions as well. However, the rules about hardship withdrawals from these dollars may be different from the rules about hardship withdrawals from your elective contributions.
You can’t necessarily take the entire amount that’s available for hardship withdrawal, however. You can only withdraw the amount necessary to satisfy your financial need. Your employer may ask for documentation to support the amount of your request, such as copies of bills or a purchase and sale agreement for a home.
How to get a hardship withdrawal.
There are five main steps to take a hardship withdrawal:
1. Determine how much money you need and whether there is any other reasonable way you can cover the cost.
2. Check with your plan administrator to find out if your plan allows hardship withdrawals, the requirements to qualify, and the maximum amount you can withdraw.
3. Request a hardship withdrawal from your plan administrator. This will typically involve filling out some paperwork and providing proof of hardship, if requested.
4. Get your spouse’s consent, if necessary (your plan administrator will let you know if you need to do this).
5. Pay any income tax and/or penalties due on the hardship withdrawal. You will typically do this when you file your federal and state income tax returns for the year of the withdrawal.
What else should I think about?
A hardship withdrawal is generally treated as taxable income to you for federal (and possibly state) income tax purposes. In addition, if you aren’t at least age 59½, a 10% early-withdrawal tax may apply. Before taking a hardship withdrawal, it’s a good idea to consult a tax advisor about any income tax implications.
Be sure to also consider the long-term financial impact of your choice. While short-term needs have to be taken care of, remember that you only have one retirement. By taking a hardship withdrawal, you’re not just diminishing the amount you have for retirement by the amount you withdraw, you’re also depriving yourself of any investment growth you might have earned on that money if it had stayed in your account. In addition, if you’re barred from making contributions to your account after taking a hardship withdrawal, you’re missing out on matching funds from your employer too. If you’re a long way away from retirement, that could translate into a significant amount.
Whatever hardship you’re facing, know that you have options. Consider all the different sources you have to get money, and the potential consequences of each. Having a trusted advisor on your side can help as well. Finding the right solution can help you take care of your needs in the present, and set you back on the path to a bright future.
Part of this content has been contributed by Broadridge Investor Communication Solutions, Inc.