Making Sense of 401(k) Hardship Withdrawal

How Can I Take a 401(k) Withdrawal Without a Penalty?

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401k questions and answers
Bill's Answer: Answered by Daniel Cohen

A 401(k) plan is a type of tax-qualified deferred compensation plan in which an employee can elect to have the employer contribute a portion of his or her cash wages to the plan on a pre-tax basis. These deferred wages (commonly referred to as elective deferrals) are not subject to income tax withholding at the time of deferral, and they are not reflected on your Form 1040 since they were not included in the taxable wages on your Form W-2.

However, they are included as wages subject to Social Security, Medicare, and federal unemployment taxes.

Some plans allow employees to make a 401(k) hardship withdrawal because of immediate and heavy financial needs. Generally, 401(k) hardship distributions are limited to the amount of the employee’s elective deferrals only, and do not include any income earned on the deferred amounts. Hardship distributions are not treated as eligible rollover distributions.

Tip If debt problems are the reason you are looking to take out money from your 401(k), get a no-cost, no obligation analysis of your debt options from a pre-screened specialist. It makes sense to evaluate your debt options in parallel with exploring 401(k) hardship qualifications.

401(k) Hardship Withdrawal Basics

A 401(k) hardship withdrawal is not like taking a loan from your 401(k) account. The withdrawal may be difficult to get, and costly to receive. Your 401(k) is intended to provide retirement income and should be a last-resort source of cash for expenses. IRS rules allow plan withdrawals (called distributions) in a limited number of hardship situations. To further discourage early withdrawals, Congress wrote harsh rules to impose a penalty tax in many situations.

Congress allowed two types of hardship withdrawals in 401(k) and other deferred-tax retirement savings plans. One subject to applicable income taxes plus a 10% early withdrawal penalty tax if you are younger than 59½. The other is a penalty-free withdrawal made under Section 72(t) of the Internal Revenue Code. With this, you pay applicable income taxes but not an early withdrawal penalty tax.

You may receive a 401(k) hardship distribution because of an “immediate and heavy financial need” and the distribution “is necessary to satisfy that financial need.” Let's look at the rules for penalty and no-penalty distributions, as found in IRS document Topic 558 and the IRS 401(k) Resource Guide - Plan Participants - General Distribution Rules. Refer to both of these documents for clarifications on the rule below.

Distributions Subject to a 10% Penalty Tax if You Are Less Than Age 59½

According to the IRS, the following reasons may be allowed by your plan's administrator for a 401(k) distribution:

  • Expenses for medical care previously incurred by the employee, the employee’s spouse, or any dependents of the employee or necessary for these persons to obtain medical care;
  • Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
  • Payment of tuition, related educational fees, and room and board expenses, for the next 12 months of postsecondary education for the employee, or the employee’s spouse, children, or dependents;
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence;
  • Funeral expenses; or
  • Certain expenses relating to the repair of damage to the employee’s principal residence.

Distributions Exempt From a 10% Penalty Tax

According to the IRS, the following reasons may be used for a penalty-free 401(k) distribution:

  • Distributions made to your beneficiary or estate on or after your death.
  • Distributions made because you are totally and permanently disabled.
  • Distributions made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary. If these distributions are from a qualified plan other than an IRA, you must separate from service with this employer before the payments begin for this exception to apply.
  • Distributions to the extent you have deductible medical expenses that exceed 10% of your adjusted gross income (7.5% if you or your spouse is 65 or over) whether or not you itemize your deductions for the year. The 7.5% limitation is a temporary exemption from January 1, 2013 to December 31, 2016 for individuals age 65 and older and their spouses. For additional information, see IRS Topic 502.
  • Distributions made due to an IRS levy of the plan under section 6331.
  • Distributions that are qualified reservist distributions. Generally, these are distributions made to individuals that are called to active duty for at least 180 days after September 11, 2001.
  • For 401(k)s and similar plans (but not IRAs), these three exceptions also apply:
    • Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55, or distributions made from a qualified governmental defined benefit plan if you were a qualified public safety employee (State or local government) who separated from service on or after you reached age 50.
    • Distributions made to an alternate payee under a qualified domestic relations order, and
    • Distributions of dividends from employee stock ownership plans.

Plan administrators and employers are not required to offer either type of 401(k) hardship withdrawal, so check with your administrator to learn which type of distribution, if any, is available to you.

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For more information, see the IRS’s 401(k) Resource Guide.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

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Comments (230)


Hn N.
Charleston, SC  |  March 11, 2014
I was full time employee in a medical university. Recently I enrolled in the same school and quit from my job. I receive a scholarship from the same institute. From my employer I came to know I cannot continue my retirement fund as I am student. So I wanted to terminate and retirement fund and like to withdraw my saving. But now they are saying I cannot do that either as I am not out of the institute/disable/59 years! they do not even clarify what will happen to my savings. I appreciate any advice!
Bills.com
March 12, 2014
Ask the 401(k) administrator for the forms to roll-over your account into an IRA. Then do so. Make sure you understand the heavy tax implications of taking a distribution from your IRA before you do so.
GM M.
Lancaster, TX  |  February 25, 2014
I'm 37 and currently unemployed due to a lay-off. I do not receive unemployment benefits anymore. As of yet, I do not have a job offer. I have an overdrawn checking account. I have $10,000 in 401K. Can I cash it out without paying a penalty, so that I can pay my mortgage?
Bills.com
February 26, 2014
Under the 401(k) law, Congress created two classes of hardship withdrawals. One is subject to the 10% penalty tax, and the other is not. See the list above and the IRS 401(k) resource guide for clarification on this rule.

You can argue you face foreclosure if you do not take a distribution. This type of hardship withdrawal is subject to the 10% penalty tax. Consult with the IRS or a tax professional for clarification of this rule.
Tonilynn T.
Katy, TX  |  February 21, 2014
I was injured on my job and was awaiting benefits from OWCP, it took them 4 monthsto pay me. In the mean while my husband was laid off and our bills were piling up. I was close to being foreclosed on so I had to take a hardship. I was out on disability leave for 9 months. When I filed my taxes the IRS is saying I owe $4k. I paid the 10%, so I thought. Is there anything I can do?
Bills.com
February 21, 2014
It is very difficult for us to answer a reader's specific tax question because we never have enough information about reader's situation. Consult with an experienced tax preparer, or a tax lawyer for answers to your questions
Dana A.
Colfax, WI  |  February 09, 2014
Hi, I have a need for medically necessary surgery. I'm 100% vested. If I need my 401k money for surgery, do I still have to pay taxes and withdrawal fees if the total amount taken out is used for the surgery? Thanks Dana
Bills.com
February 11, 2014
The penalty-free exception for medical expenses applies if you are in debt for medical expenses that exceed 7.5% of your adjusted gross income. Therefore, it depends on the cost of the surgery and your current income. I recommend speaking with both your 401k plan administrator and certified tax specialist, to make sure that you don't take an action without fully understanding the tax consequences.
Christy S.
Melbourne, FL  |  February 03, 2014
My husband has been put on medical disability idefinitately due to a stroke. He is only 31. Is there anyway to withdrawl the 401k entire vested balance? We will need due to his long term not being effective for 170 more days.,
Bills.com
February 03, 2014
It sounds as if your husband meets the requirements for a penalty-free withdrawal. Speak with his plan administrator to confirm that.

I also suggest that you speak with a tax professional. Because you have to pay income tax on whatever is withdrawn, it may make sense to take some in 2014 and some in 2015, if it would keep you in a lower tax bracket.
Eric L.
Baltimore, MD  |  January 29, 2014
I recently quit my job i asked to receive my full payout on my 401k and it been three months and still have not got it. What should i do?
Bills.com
January 29, 2014
Contact the plan administrator at your old job and find out if a check was sent. If so, find out where and make arrangements to get another one sent. If not, request that they send it to you.
Courtney B.
Indianapolis, IN  |  January 18, 2014
My wife is in her last quarter of nursing school and i was wanting to know if i could get a hardship to pay her tuition off with my 401k.
Bills.com
January 23, 2014
The general rules do allow a person "(T)o pay college tuition for yourself or a dependent, provided the tuition is due within the next 12 months." As your wife is not your dependent, it doesn't seem to meet the rules. I suggest that you speak with your 401k plan administrator.
Ed S.
Murphysboro, IL  |  January 12, 2014
What would your suggestion be on withdrawing my wife's S.U.R.s Retirement, she is in nursing home, was dx with vascular dementia and hasn't worked at state college since 2008. I am her POA on finanical and on health. Would a Attorney be a best interest?
Bills.com
January 13, 2014
Tax issues are tough for us to answer because we never have enough information about a reader's situation. Consult with a tax lawyer to discuss your options.
Jor-el M.
Sanford, NC  |  January 06, 2014
Can I take a 401k hardship to pay back child support? I've already taken a loan to get married. I recently got a letter for me to go to court for the arrearages. If I don't pay I'll go to jail, and lose my job, and in turn lose my house.
Bills.com
January 06, 2014
Speak with your plan administrator. There are allowances made for a penalty-free withdrawal when a person is "required by court order to give the money to your divorced spouse, a child, or a dependent."
Danielle K.
Port Carbon, PA  |  January 01, 2014
If my car was repossessed and I am now being sued for the difference would i be able to take a hardship withdrawl
Bills.com
January 02, 2014
Unfortunately, your need for money, though quite understandable and reasonable, does not meet the definition of a hardship for a 401K withdrawal. Still, speak with your plan administrator to hear what they say.
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