What is a 401(k) Hardship Withdrawal?

If you’ve been planning for retirement and have a 401(k) account through your job, your plan may allow you to make a 401(k) hardship withdrawal in a time of need. Withdrawals from a 401(k) are not very common,¹ so it’s a good idea to understand more before making a decision.

Let’s dive deeper into what 401(k) hardship withdrawal is, how it works and when you might consider making one.

What is a 401(k) hardship withdrawal?

A 401(k) hardship withdrawal is an approved withdrawal from your 401(k) account that you may make if you have a financial emergency before age 59 and a half. At that age, you’re allowed to begin taking distributions without an early withdrawal penalty. Because traditional 401(k) withdrawals count as income, you’ll owe income taxes on the money you take out plus a 10% early withdrawal penalty in some cases.²

The specific hardship eligibility rules are determined by your individual 401(k) plan and the Internal Revenue Service (IRS) regulations. Your plan administrator isn’t required to allow all hardship withdrawal requests. You should check with your plan administrator to clarify the rules for your plan.

When can you take a 401(k) hardship withdrawal?

Your circumstances must meet IRS eligibility requirements to make a 401(k) hardship withdrawal. The IRS only allows hardship withdrawals due to an “immediate and heavy financial need” for you, your spouse, dependents or beneficiaries.³ You may have to provide your employer or plan administrator with proof of your financial hardship and confirm that you can’t pay with other means. You may only withdraw the funds you need to cover your financial needs. Even if you qualify under IRS regulations, you may have to meet additional requirements under your retirement plan. Some common qualifying situations according to the IRS include:

Medical expenses

A serious diagnosis or injury can be very expensive, especially if you or your loved one has a long recovery period. With everything on your plate, a medical bill should be one less thing to worry about. If you have no other way to pay, your plan administrator may allow you to use a hardship withdrawal to help you cover some or all the medical expenses for you, your spouse, a dependent or a beneficiary, so you and your loved ones can focus on recovery.

Costs to prevent eviction or foreclosure

A spouse’s job loss, unexpected bills or rising housing costs can make it tough to keep up with rent or mortgage payments. If you fall behind and are at risk of losing your home, a 401(k) withdrawal may help. You may use 401(k) funds through a hardship withdrawal to cover the rent or mortgage payments necessary to prevent eviction or foreclosure, as long as the dwelling is your primary residence.

Funeral costs

Burials and funeral services may cost several thousand dollars or more.⁴ If you’re not able to cover funeral costs another way, your 401(k) withdrawal may help cover the costs of laying to rest a spouse, dependent or beneficiary. If you pass away, your loved ones may also withdraw money from your 401(k) to cover the burial and services, giving them space to grieve without stressing over funeral costs.

Repairing damage to a primary residence after an emergency

If you don’t have a homeowner’s insurance policy or it doesn’t fully cover the cost of restoring your primary residence after an unexpected event or natural disaster, repair costs may qualify for a hardship withdrawal. Some qualifying events may include:

• water damage from a flood
• roof damage from a tornado
• smoke damage from a fire
• structural damage from an earthquake
• burst pipes from an ice storm

Educational expenses

It’s no secret that higher education is very expensive. If you, your child or your spouse can’t cover the entire cost with other forms of financial aid like loans, grants and scholarships, you may be able to use a 401(k) hardship withdrawal to help pay for the next 12 months of postsecondary educational expenses like tuition or room and board. Before making a hardship withdrawal, however, you may want to explore grants, scholarships and student loans.

How does a 401(k) hardship withdrawal affect your taxes?

A hardship withdrawal from your 401(k) has tax implications.

Any money you take from a traditional 401(k) counts as income, meaning you generally have to pay federal, state and local income taxes on the withdrawal.⁶ Your tax rate depends on your income level and filing status, but it’s often between 10% and 30% for many Americans.⁷

You may also owe a 10% penalty for withdrawing funds before age 59 and a half. In the case of some hardship withdrawals, including withdrawals for medical expenses or disaster recovery, you may not have to pay the penalty. But other hardship withdrawals, including funds for prevention of eviction or foreclosure, educational costs, and funeral expenses, may still be subject to the 10% penalty. Check out the IRS guidelines for more information. You may also want to consult a tax expert if you have questions about your specific situation.

How do you make a 401(k) hardship withdrawal?

The specific process to complete a hardship withdrawal may vary by plan administrator, but it typically looks like this:

1. Confirm you can make a withdrawal. Review the summary plan description (SPD) — a document your plan administrator provides that outlines the key details of your plan — to confirm whether your 401(k) allows hardship withdrawals.
2. Request a withdrawal. Typically, the SPD will outline the forms you need to fill out and where to submit them. You can reach out to your plan administrator if you’re not sure of the process.
3. Provide any required documentation. You may need to provide supporting documentation that shows how much you need. Some plans may also require you to show that you don’t have any other money available to pay for the expense.
4. Receive the funds. If your request is approved, the plan administrator processes the withdrawal and releases funds to the designated bank account. Standard withdrawals tend to take between five and seven business days, but hardship withdrawals tend to take longer due to the paperwork and proof required.⁵

Pros and cons of a 401(k) hardship withdrawal

Your 401(k) is a great tool to save for retirement, so you shouldn’t make early withdrawals without fully considering the pros and cons.

Pros

• No debt: A 401(k) hardship withdrawal is not a 401(k) loan, meaning you won’t have to make monthly payments to repay the money you withdrew.
• Potentially no penalties: You may avoid an early withdrawal penalty if your expense meets the IRS’s rules for a penalty exception.
• No credit check: Because 401(k) funds already belong to you, you don’t have to qualify for credit. If you have a troubled credit history or are in a difficult financial situation, your 401(k) funds may be easier to access than a loan.

Cons

• Tax implications: Your 401(k) balance is not taxed. But if you make a withdrawal from a traditional 401(k), you’ll have to pay income tax on the amount you take out.
• Not offered by all plans: Your 401(k) plan administrator may not offer hardship withdrawals that align with your needs.
• Reduces your retirement funds: After making a 401(k) hardship withdrawal, you’ll have less money to fall back on in retirement. Shrinking your nest egg may reduce your ability to navigate financial emergencies in the future or force you to stretch your resources after you retire.

Alternatives to a 401(k) hardship withdrawal

A 401(k) hardship withdrawal can have a big impact on your financial future. There are other ways to cover unexpected expenses without reducing your retirement savings.

• Other savings: If you have non-retirement savings accounts, like an emergency fund, consider using that money first.
• Personal loan: With a personal loan, you could receive fast funding to address necessary expenses without tapping into your retirement savings. OneMain offers personal loans for many financial needs, including medical bills, home repairs and debt consolidation. You can receive your funds all at once to cover the need and repay the loan over time with a fixed interest rate and predictable monthly payments.
• Home equity loan: In some cases, you may be able to take out a loan backed by your home equity (the difference between what you owe on your mortgage and the value of your home). But remember, you could lose your home if you’re unable to repay the lender.
• Home Equity Line of Credit (HELOC): You may also be able to open a HELOC, a revolving line of credit that allows you to borrow money against your home’s equity up to a certain limit.
• Grants: If you need money to cover college tuition or recover from a disaster, you may qualify for grant money from government agencies or nonprofits, which you don’t have to repay.
• 401(k) loan: A 401(k) loan allows you to borrow money from your 401(k) savings. Unlike a hardship withdrawal, you restore your 401(k) by paying back the loan with interest over a set term.

Before requesting a 401(k) hardship withdrawal, speak with a financial or tax advisor to explore your options, so you can make the choice that’s right for you.

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Cover your hardship with confidence

Making a 401(k) hardship withdrawal is a big decision. Before requesting a withdrawal, make sure you understand how your plan works and that you qualify for a hardship exception. Speaking with a tax expert or financial advisor can help you weigh the impact of the decision and explore potentially better alternatives for your specific situation.

Sources

1 https://www.newsnationnow.com/business/your-money/americans-tapping-401ks-emergencies/
2,3 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions
4. https://nfda.org/news/statistics
5 https://smartasset.com/retirement/how-long-does-it-take-to-withdraw-money-from-401k
6 https://www.investopedia.com/articles/personal-finance/051614/when-401k-hardship-withdrawal-makes-sense.asp
7. https://www.irs.gov/filing/federal-income-tax-rates-and-brackets