401(k) Withdrawal Rules: Taking Hardship Distributions From Plans

Nov 27, 2010
Carol Finch

What are the 401(k) Withdrawal Rules for Hardship? - Image by cobrasoft

Those looking to take an early withdrawal from a 401(k) plan may have to pay a tax penalty. In some cases, however, 401(k)s may allow hardship withdrawals.

There may be times when it would be useful to take an early withdrawal from a 401(k) plan. Not waiting until the designated age of 59½ may add a penalty charge to regular income tax liability. Some 401(k) withdrawal rules, however, allow for hardship distributions. When can a plan holder withdraw cash from a retirement plan on a hardship basis?

401(k) Withdrawal Rules and Early Withdrawal Charges

Generally, 401(k) retirement funds are meant to be withdrawn from the age of 59½. Any withdrawals made from this age onwards will be liable to standard income tax charges. If, however, you plan on making an early withdrawal (i.e. before the age of 59½), then you may also have to pay a IRS penalty tax charge of 10%. This penalty may not be applied in the case of hardship distributions.

What are 401(k) Hardship Withdrawals?

There are certain times when the IRS will waive the 10% early withdrawal penalty for 401(k)s. These are known as hardship withdrawals or distributions. The options available may vary, but typically include:

The purchase of a first home.
Higher education/college costs.
Some medical expenses.
Payments to avoid eviction or foreclosure.
Burial or funeral costs.
Expenses needed for repair/damage to a home.

Keep in mind that 401(k) withdrawals may not meet hardship criteria if the individual has other assets or resources that could be used as alternatives.

Do All 401(k) Plans Allow Hardship Distributions?

Not all 401(k) plans have to allow for hardship withdrawals, although many do. Those that do provide this option may not, however, all operate in the same way or set the same criteria. Some may offer all allowed circumstances; others may specify that hardship only applies in certain situations. It is important to check plan rules first, rather than assuming that all early withdrawals will be eligible.

Are 401(k) Loans a Good Alternative to Hardship Withdrawals?

If a hardship withdrawal is not possible, either because it is not available in a plan or because the individual is not eligible, then it may be possible to look at a 401(k) loan instead. The money borrowed will need to be repaid within a set period of time in order to avoid income taxes and the 10% penalty charge. This may be a viable solution for some. Others may prefer not to borrow against their retirement savings as this can affect overall returns over time.

Sources: IRS.gov; CNN Money. Accessed online 27th November 2010.