There are times that you may need emergency money and the only ones available are your 401k retirement plan. You may be able to make a 401k hardship withdrawal but it comes with a lot of caveat. Please keep in mind that 401k Retirement plan does not have the same leniency present with the IRA, where you can withdraw the funds at any time. You may also first consider taking out a 401k loan as this may be a better option.
The Requirements of a 401k Hardship Withdrawal
The IRS is allowing you to make a hardship withdrawal if you have a financial need but they have very strict guidelines for doing so. This is because your retirement are supposed to be used for one purpose only: your retirement. In fact there are various penalties that you may potentially incur if you withdraw money from your 401k even if it’s for a hardship and this will be discussed later.
- Example – You cannot just take the money out so you can go on that Caribbean cruise that you’ve been dreaming about. In addition, you cannot just take the money out because you’ve been wanting to have your kitchen remodeled or upgraded so you can impress your friends. However, repairing damages to your may home qualify and this will be discussed later.
The financial need clause is not limited to just the employee: The financial need of the spouse, dependent, domestic partner, or non-dependent beneficiary are also considered. The maximum amount that you can take out is limited to the amount that you contributed but you may be allowed to use the company matching contributions as well depending on your plans provisions. Although there may be more cases, the following are the most common ones that qualifies for the financial need:
- Certain medical expenses
- Burial or funeral expenses
- Cost pertaining to the purchase of a principal residence
- Tuition and related educational fees and expenses
- Certain expenses to repair a major damage to the employee’s principal residence
- Payments necessary to prevent eviction or foreclosure of the employee’s principal residence.
When it comes to a major damage of your home, you cannot make a 401k hardship withdrawal if you are expecting a reimbursement from the insurance company but you can make a withdrawal for the amounts that your insurance company does not cover.
- Example - Your home is damaged from a flood and it will cost you $50,000 to fix it. Your insurance company told you that your policy is only covering you for up to $20,000 reimbursement. You cannot withdraw the full $50,000 from your retirement plan and you will be limited to $30,000 only.
As mentioned before, you should not take the money out of your retirement plan at all times because of the penalties and interest. In summary, taking a 401k hardship withdrawal comes with the following consequences that you should know about:
- You lose the opportunity for growth of your retirement plan.
- You still pay the 10% early withdrawal penalty if you are doing it before the age 59.
- Your withdrawal is included in your gross income, which means it is also taxable. It may also put you into a higher tax bracket and pay a higher tax rate.
- You are not allowed to make any contribution to your 401k plan or any other retirement plan for six months.
This is why I strongly recommend individuals to establish an emergency fund so that they do not have to touch their retirement money when the unforeseeable bad event happens. Or, you should look at other resources such as credit cards, bank loans or borrowing money from your relatives.
The rules for 403(b) is the same as the 401(k) but 457 retirement plans are quite different.
What about you, do you think taking a 401k hardship withdrawal is a good idea?
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