Information on 401(k) hardship and withdrawal rules - The Bills.com Blog

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Information on 401(k) hardship and withdrawal rules

Monday, Oct 29, 2007

Question: I read that at age 55 I can withdraw my 401(k) without penalty as long as I am leaving my job. Is this true for all 401(k) plans? Are there any specific reasons one has to have for withdrawal without penalty?

Answer: 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.

Many 401(k) plans allow employees to make a hardship withdrawal because of immediate and heavy financial needs. Generally, hardship distributions from a 401(k) plan 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.

Hardship Basics
A hardship withdrawal is not like a plan loan. The withdrawal may be difficult to get, and costly if you receive it. Remember, your 401(k) is meant to provide retirement income. It should be a last-resort source of cash for expenses before then. IRS rules allow plan withdrawals in a limited
number of hardship situations. To further discourage early withdrawals, in some cases the IRS imposes a hefty financial penalty.

Two types of hardship withdrawals are permitted from 401(k) plans. One is called a financial hardship withdrawal. It is subject to applicable income taxes and a 10% early withdrawal penalty if you are younger than 59 1/2. 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.

Financial hardship withdrawals are allowed for the following reasons:

To buy a primary residence

To prevent foreclosure or eviction from your home

To pay college tuition for yourself or a dependent, provided the tuition is due within the next 12 months

To pay un-reimbursed medical expenses for you or your dependents


You may qualify to take a penalty-free withdrawal if you meet one of the following exceptions:

You
become totally disabled.

You are in debt for medical expenses that exceed 7.5% of your adjusted gross income.

You are required by court order to give the money to your divorced spouse, a child, or a dependent.

You are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.

You are separated from service and you have set up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution you are required to continue for five years or until you reach age 59 1/2, whichever is longer.)


Remember, employers are not required to offer either type of hardship withdrawal, so you should check with your employer to see which type, if any, is available to you.

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

I hope this information has helped you Find. Learn. Save!

Best,
Bill
www.bills.com

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User Comments

can you take hardship for a fire the destroy home/primary residence

You will need to contact your plan administrator. The plan administrator will then contact the IRS with the details of your case to see if it does indeed qualify for the hardship criteria.

I am going thru a devoice.I want to go thru it the cheapest way possible. So I trying to have all ready to offer to my husband when we go to file.I wanted to withdraw from my plan to pay him.Please tell me what is possible. Thanks Windy

Windy, please contact your plan administrator to find out if your divorce qualifies as a hardship withdrawal. The rules are pretty rigid, so if the divorce does not qualify, I would advice against pulling those funds out because the penalty will be very steep.

The company I worked for went out of business while I was out for disability. I am still disabled and awaiting a hearing from the Soc. Sec Adm. I have received a check from my former 401k,how much penalty and taxes will I have to pay if I declare a hardship withdrawal? The check is $26,000 and I am 58 years old. I am financially strapped at this time and need the money to pay my bills and my medical needs.

There are only a few instances where the IRS would qualify a hardship based withdrawal. You will need to speak to your plan administrator from before and discuss your situation in detail. Your plan administrator would then see whether you qualify or not. In the event that you do not qualify, the penalty for early withdrawal (before the age of 59 1/2)is an additional 10% on top of the regular income tax that you would pay.

I have just purchased my first home which is now my primary home of residence. I had an inspection done on the house and what was wrong was the following. First water heater floor was weak and bowed, there is grout cracks in the mastere shower walls and also the second bathroom. The back door is not closing shut due to the frame is rotted and the front door frame look like someone may have kicked the door in. Also the hot water heater TPR Line & Flue is not connected, I was told by the inspector that this is hazardous and require immediate attention. I have gotten a estimate on the repairs and my insurance stated that this is not covered in the insurance. My question to you is I have offical documents supporting all of this, can I take out an Hardship withrawl from my 401K for these repairs?

You will have to consult with your plan administrator to find out whether or not what you have explained in your question, qualifies as a valid reason for a hardship based withdrawal. The IRS has strict rules governing it and only a plan administrator can help in this regard.

i have 1 401[k]loan already but owe irs and they garnising my wages and need loan before i loose everything

Please talk to your plan administrator about getting a loan against your 401k savings, it can be done quite easily.

I was fired from my job and was forced (by my employer) to get a disability designation. I can't live on this tiny disability benefit, since they took away my retirement from me forever. I was hoping to start a business, but I don't have the money to live on unless I take the money from my 401K. If I get any income from this business eventually, will I have to pay a penalty at that time? There is not a huge amount in the 401K, so can I take all of the money at one time? My employers also told me that I would have to pay back ALL of the disability benefits that I have received so far, if I recieved any income. Is this true? Is this income? I'm 54.

You will pay the penalty for the 401k withdrawal regardless of your current income situation. I am guessing that, what your employer means is that if you earn any income while you are disabled, you should not be getting any disabilty benefits from them as you are earning an income elsewhere, but if you have no income right now, they cannot ask you for the money back. But, they can stop your disability benefits once you start earning through your new business.

I'm not asking what they meant. They were explicit that their intention is to take away ALL of the benefits that I have received for the past years, if I am able to get an income to survive on. What I'm asking is if it is legal for them to do this. If not, is there a resource that I can rely on to protect myself. From my experience with the "plan administrator", they will NOT "ask" my permission to take money from me. And I am asking if my 401K is "income" for the purpose of taking away this "benefit", if I were to take this money to live on, while I get a business up and running. And, returning to my first question, your blog says "you may qualify" to take a penalty-free distribution if "you become totally disabled". Of course the life-threatening conditions that I'm living through, will not disappear just because I don't have the money to pay for life. So, I guess there are two parts to this question. First, I'm asking if there is a way to get a definite answer on if a person qualifies for this penalty-free status? And second, will the IRS renege on this, once and hopefully when I have enough money to survive on? Is it possible to get this money at one time? Obviously, I don't want to lose any more money than I have to, after losing my retirement and having to pay the expense of getting fired.

The best way to find out, for sure, if you qualify for penalty-free distribution will be to consult with a tax attorney or a tax professional (a CPA, for example). I don’t really know enough about your situation to tell you whether or not your disability would exempt you from early withdrawal penalties. Even if you are not penalized, remember that you will likely still be required to pay taxes on the money you withdraw, which is usually around 20%. If you are allowed to make a penalty-free withdrawal, and are later able to start a business, I cannot imagine that the IRS would ask you to pay the penalty after-the-fact. Generally speaking, the IRS will look at your situation at the time of the withdrawal to make its determination as to whether or not the penalties will be incurred; future changes to your disability status should not cause a problem. Since I cannot provide you with tax advice specific to your circumstances, I strongly encourage you to consult with a tax professional about this situation to make sure that this withdrawal will not cause you problems down the road. As for your former employer’s legal ability to require you to repay your disability benefits, this depends primarily on the type of disability benefits you are receiving and the contract between you, your employer, and the disability insurance provider. Federal law strictly regulates withdrawals from 401k accounts, so even if you are contractually required to repay your disability benefits, I doubt that your former employer could simply dip into your 401k fund to repay the insurer. Again, I do not know the details of your situation and cannot provide you with legal advice, so I strongly encourage you to consult with an attorney licensed in your state.

That certainly does not sound legal, but if I were you I would seek counsel from a local attorney to review your 401k plan, your disability income and your issues with your former employer. Good luck.

Thank you for your response. My "retirement account" was NOT the same as my 401K account. My employer has already taken away my retirement account. I don't have the money to pay for a lawyer, unless I take the money from the 401K. In that case, it is too late to save the money that I have worked to put in this account. I know the trend to make the tax law unaviable for most people is certaintly not your fault, and I'm not blaming you. However, we really need to get some change in our laws to protect people (not the people who have the money to have a lawyer).

I was recently laid off my job due to workforce reduction. I have not found employment yet due to the tough times now and need to use 401K funds from previous employment. I'm not yet 55 and wonder if I would qualify for penalty free hardship.

You will need to discuss that with your plan administrator. You can read more about hardship rules at: http://www.irs.gov/retirement/article/0,,id=162416,00.html

My job was eliminated 4 months ago... the week of my 60th birthday. At the time of my termination, I was repaying a 401(K) loan that had helped me purchase my home. That loan still has a balance of about $1500. Since I am unemployed, I cannot repay it. My questions: Since I am now 60 abd tge loan is not yet in default, am I right in assuming it will be treated as taxable income without the 10% penalty? Can I withdraw all or part of the remaining balance to help while I'm unemployed?

Yes, as you are above the age of 59.5 you will not have to pay the 10% penalty for early withdrawal.

I took out a 401-K hardship withdrawal, which I took 10% tax out for federal and 10% tax out for State. I am under 55 years old. Doing my taxes I owe $3600.00 because I went to the next tax bracket with the amount I withdrew. I asked my advisor before I was doing this, what I should take out and he said 10% for Fed and 10% for state would be enough. Obviously it wasn't and the reason I took a hardship withdrawal was because I couldn't pay my mortgage and now I have to pay the IRS. Is there anything I can do to rectify this situation?

Doreen, the 10% that you paid is only the penalty for early withdrawal. What you are doing now is paying your income taxes on the withdrawal (adding the amount withdrawn to your income for the year). I doubt that you will be able to fix this as the transaction has already taken place.

I am divorced and going back to school(University & receiving FSSA and going to another school (flying helicopters) to get the experience-they both go hand in hand). My question is: I need a large amount of money and I have it in a 401K. I am 45 yrs. old. What can I anticipate for a tax penalty for an early withdrawl? Double tax or a one time tax? I am only working P/T and can not find a person with a decent worthy credit for a loan-co-signer. I own my own house and have taken part of the 401k (court ordered) to purchase and update the necessary means with the house I am in now. I need more money to continue my education...It is not all a tuition problem.

You are looking at a 10% penalty right at the time of withdrawal. Let's say you withdraw $10000, you will only receive $9000 in hand. You will also have to add the $10000 to your yearly income and pay taxes on your total income.

I suddenly became a single parent near a decade ago and a year later became guardian to a critically ill parent now passed, during which time I got deeply in debt, now struggling to hang on with mortgage payments late but current, and being the last thing still current, will I qualify for a hardship withdrawal, I ask because my largest debtor is willing to settle and this is the only resource I have left, besides bankruptcy?

YOu can read more about hardship withdrawals here: http://www.irs.gov/retirement/article/0,,id=162416,00.html. You will need to speak to your plan administrator to see if you qualify for a hardship based withdrawal.

hi, I have a question by b/f is already collecting unemployment.His 401k has 14,000 in it can we take a hard ship out on it? how does that work with unemployment we live in mass. He as a loan out on it already he owes 590$left on it.

Your husband will need to talk to the plan administrator and see if he qualifies for a hardship based withdrawal. You can read more on IRS's website at: http://www.irs.gov/retirement/article/0,,id=162416,00.html

I was recently let go from my job of 13 years. I am 56 years old. If I take my 401K as a cash dispersment will I have to pay a penalty? I also took a loan last year which I will be unable to pay back. Since I am over 55 will that have a penalty? Thanks.

If you withdraw from your 401k before you are 59 & 1/2 years old, then you will have to pay a 10% penalty. There are scenarios where you could claim a hardship based withdrawal, but the IRS has strict guidelines as to what qualifies for a hardship. You should speak to your plan administrator to find out if the fact that you are currently unemployed will qualify you for a penalty free hardship based withdrawal.

is there a certain length of time or a certain about of money you have to invest in your 401(k)before you can request for a hardship

The IRS has strict requirements of what qualifies as a hardship, for more information, please see here: http://www.irs.gov/retirement/article/0,,id=162416,00.html

In 2007 I was terminated from my job. At that Time I was 58 years old. In Jan of 2008 I closed my 401k that I had with my employer and used the funds to live on. At this point in time I am still unemployed and will be turning 60 this month. When I filed my income tax return I used Turbo tax and said I had to pay a 10% penalty. Was this correct or could I have waived the penalty because of loosing my job and being over 55 years old?

If your withdrawal was done before you turned 59 1/2 then you are liable to pay this penalty. if you wanted to claim a hardship withdrawal, you should have made sure that you checked if you qualify based on the ITS rules. You can read more here: http://www.irs.gov/retirement/article/0,,id=162416,00.html

I am stuck in a high interest mortgage and cant get a refinence with the market i am falling behind on alot of bills. Would I be able to get a hardship withdrawal to pay off my mortgage?

If you check on the IRS's website (http://www.irs.gov/retirement/article/0,,id=162416,00.html#1) here is what I see as one of the hardship criteria: (4) payments necessary to prevent eviction from, or foreclosure on, a principal residence. Therefore if you are having trouble with your mortgage, you may qualify for a penalty free withdrawal, but make sure you check with your plan administrators as retirement plans may, but are not required to, provide for hardship distributions.

I need to cash-out my 401k. I will be 59 in June, I have estimated $700.00 in my 401k that I need to cash out due to: I lost my mom last year, My father has been diagnosed with terminal canser and has been given 6 months to live. I live in Georgia and my father lives in Mo. I have been flying out every 2-3 weeks, and I have no other cash to continue these trips. Can this be considered a hardship? If not, what amount in penalties will I have to endure?

You will need to speak to your plan administrator to find out whether or not your hardship qualifies for a penalty free withdrawal. You will have to be older than 59 & 1/2 years old to avoid the penalty on the withdrawal.

I am in the process of refinancing my mortgage. Would this qualify as a hardship withdrawel to pay the closing costs on a refinance?

I don't think that will qualify, see here: http://www.irs.gov/retirement/article/0,,id=162416,00.html

Does dental work not covered by insurance meet the definition of medical expenses as one of the hardship reasons?

It sure could Ron. I think that uncovered medical debt counts, so uncovered dental expense just might qualify - but you should seek direct counsel from a tax attorney or from your 401k administrator to confirm if dental work would qualify for penalty free distribution under the hardship rules. Good luck. bills.com

I was recently laid off my job due to workforce reduction after 11 years back in March. I have not found employment yet and due to the economic downturns I may need to use my 401K funds as O cannot wait for the Obama stimulus plan to help me in time. I was 55 at the time of the layoff. I am wondering if would qualify for the penalty free hardship clause, and if so how long does it generally take from the time you file for the withdrawl till the check reaches you?

You can withdraw, without penalty, funds from your 401(k) if you are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later. You wrote, "I was 55 at the time of the layoff," which places you in the no-penalty box.

Hi I am 53.5 yrs old.I am laid of from work now and it looks like the company will be out of bussiness at the end of this year when I turn 54.I have an option to roll my 401k over to my ira with other institution or leave it the way it this with john hancock the current administrator.can I leave it there one more year and when I turn 55 next dec 2010 withdraw Under the 72t rule provided that I have a financial hardship which I am anticipating since my other resouces would be running out by then?or because of the compny went under 1 year earlier that I am not qualified and considered leaving the job at 54 and not 55.but since the 410k was never touched would the irs even know?I hope you understand my questions. Thanks Mike

The safest course of action is to assume the IRS either knows everything about your finances or can learn anything it wants to about them after the fact. I don't see a non-penalty hardship withdrawal available for you, unless you use the funds for paying medical bills, or the other reasons allowed. See your tax planner to determine if rolling your 401(k) to an IRA gives you additional flexibility: See http://www.bills.com/blog/ira-vs-401k-plan/ for more information.

my 401k plan adminitraitor has been giving my the run around. I sent in paperwork for a withdraw for tuition but they turned it down and wanted letters from the school and a other stuff. My question is can they keep my money? even if im willing to pay the penalties.If I Just tell the to send me a check can they refuse?

Remember, Congress created basic 401(k) hardship and loan rules, AND gave plan administrators the right to tighten those rules when setting-up their 401(k) plans. Obviously, I know nothing about the specifics of your plan. Sit down with your administrator one more time, and ask him or her to explain the issues in the way of getting a loan from your 401(k) and really listen to the answers. The "runaround" you are getting may be basic paperwork tasks that you need to complete that may seem pointless, but actually serve to document that the administrator is maintaining the company 401(k) in accordance with the law.

Unable to obtain a student loan for my son's college due to my lousy credit. I do not see any other way but to withdraw funds from my AXA IRA rollover. Are the withdrawl rules the same as the ones for a 401k? I need $35,000, what is the total penalty plus taxes? I am 58 years old. Thanks. Ed

According to the IRS Retirement Plans FAQs regarding IRAs, "There are no prohibitions on distributions from IRA-based plans. A participant can take distributions at any time. However, in addition to the distribution being taxable, it may be subject to a 10% additional tax if the participant has not reached age 59 1/2. If the distribution is taken in the first 2 years of participation in a SIMPLE IRA plan, the additional tax is increased to 25%." A tax planner will be able to review your previous tax returns and current income to compute an accurate estimate of the taxes you need deducted.

I am 59 and 1/2 yrs old and requested a withdrawal from my 401k from my emploer. I was told I have to be separated from my employer before I can get a withdrawal. Is this true?

The rules for 401(k) plans are few, and Congress gives employers the ability to create plans with rules more stringent than outlined in the law. For example, employers are permitted but not required to allow hardship withdrawals. Regarding your question, according to IRS document 401(k) Resource Guide - Plan Participants - General Distribution Rules, "Generally, distributions of elective deferrals cannot be made until one of the following occurs...You reach age 59½ or incur a financial hardship." Distributions must begin at age 70. However, I can find no rules that require employers to allow distributions at 59½. I suggest you review your 401(k) plan documents to see under what circumstances your employer allows distributions. It is entirely possible that the human resources person -- or whoever told you a distribution was not allowed -- was completely wrong. On the other hand, your employer may have set up a very conservative plan that does not allow distributions until separation.

For more information on 401(k) plans, see the IRS 401(k) Resource Guide.

I need to make a hardship withdrawal of $3500. My company is possibly going to close in the coming weeks. Is it best to wait and withdraw once my job ends or is now just as good. Also, do I pay total of 30% in tax penalties, because the paperwork says 10% penalty imposed. When do I pay the other 20%, to who and can I just pay the full 30% upfront and get that over with?

There is no legal significance between applying for a hardship when an employer is operating or has ceased operations. In either situation, a plan administrator interprets the rules the employer wrote when setting up the 401(k) plan. The penalty taxes are paid to the IRS, customarily. See the IRS "401(k) Resource Guide - Plan Participants - General Distribution Rules" for more information on hardship rules. Incidentally, when asking 401(k) plan administrator, it is not enough to say, "I have a hardship." That is conclusory. You need to say something like, "I am facing an immediate eviction, have no other source of funds, and if I do not receive a distribution from my 401(k) plan I will be evicted from my house." Of course, what I just wrote is hypothetical and may not match your circumstances. Review the hyperlink I mentioned to see the list of all hardships Congress was willing to accept when it wrote the 401(k) laws.

For more information on 401(k) plans, see the IRS 401(k) Resource Guide.

My husband lost his job 9 weeks ago. We are currently 2 months late on our mortgage (Sept.&Oct). I have been told by my plan admin. that I can not receive a hardship withdrawl b/c I don't qualify since I have not been served with a foreclosure notice. I have explained several times that I have all of the default notices & bills to prove that we are behind. Right now the only thing that we can do to catch up, so that our credit is damaged any longer is to remove the money from my 401K account. I have been told by the lender my state doesn't take action to foreclose until 6 months in default. What can I do?

Congress created basic 401(k) hardship and loan rules, and gave plan administrators the right to tighten those rules when setting-up 401(k) plans. Sit down with your plan administrator and ask him or her to show you the rules in your plan that require you to be served with a foreclosure notice before you have a hardship. If that requirement is spelled out with clarity in your plan's rules, then your administrator is bound by the rules. However, if the plan uses the same language in the IRS "401(k) Resource Guide - Plan Participants - General Distribution Rules" then in my humble opinion the administrator is being very conservative in his or her interpretation of the rules. I am not aware of any administrative appeals process available to plan participants who believe their 401(k) plan administrator is not interpreting the rules properly. Your alternative is the court system.

For more information on 401(k) plans, see the IRS 401(k) Resource Guide.

My wife was in a car accident last year which left her permenantly disabled, she was notified that she must withdrawl her 401k or roll it over in to another plan. does she qualify for a penalty-free withdrawl if she cashes out?

See § 72. Annuities; certain proceeds of endowment and life insurance contracts for the following:

(t) 10-percent additional tax on early distributions from qualified retirement plans
(1) Imposition of additional tax If any taxpayer receives any amount from a qualified retirement plan (as defined in section 4974(c)), the taxpayer's tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is includible in gross income.
(2) Subsection not to apply to certain distributions Except as provided in paragraphs (3) and (4), paragraph (1) shall not apply to any of the following distributions:
(A) In general Distributions which are - (i) made on or after the date on which the employee attains age 59 1/2, (ii) made to a beneficiary (or to the estate of the employee) on or after the death of the employee, (iii) attributable to the employee's being disabled within the meaning of subsection (m)(7)

Subsection (m)(7) reads as follows:
(7) Meaning of disabled
For purposes of this section, an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require.

If I read Section 72 correctly, if a person qualifies as disabled under subsection (m)(7), he or she may take a distribution from a 410(k) plan without paying the 10% penalty.

Does a hardship withdrawal for college tuition include cost of books?

I know painfully well how expensive college textbooks are today, but in my opinion you would be stretching the definition of "hardship" for a penalty-free distribution from a 401(k) beyond the breaking point. Extra credit for creativity, though.

My husband and I own a small business (corp) that offers a 401K plan to employees. Due to economic circumstances we are considering a hardship withdrawal for us but is that allowable since my husband is the trustee of the plan? There are only 3-5 people even left in the plan at this point so I guess we could consider terminating the plan altogether? If we did that, could all employees get there money out even if they were still employed?

Consult with the attorney or program administration company that set up your plan to see what rules govern this situation. Each 401(k) plan is unique. Congress set up the 401(k) guidelines to give employers flexibility to create rules that make sense for the employer and employees. See the IRS document 401(k) Resource Guide - Plan Sponsors - 401(k) Plan Overview for some general guidelines. Generally speaking, if an employer winds-down a business or discontinues a 401(k) plan, it is best from a tax perspective for the employees to rollover their 401(k) balances into IRAs. I realize that I am not answering your specific questions. However, since I did not set up your 401(k) plan I cannot give you accurate information.

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