Questions about 401k hardship withdrawals come up more frequently than any other type of withdrawal from a 401(k) plan. It’s simply the most commonly known type of withdrawal to exist in most plans. And for good reason, too. (click here to learn about expanded hardship withdrawals.)
You would probably be less inclined to participate in a 401k or other type of employer-sponsored plan if you knew that you were not allowed to touch the money under any circumstances, right?
Of course you would. And no one would blame you, either.
Congress recognized this, too, and decided to offer “provisions” that would allow participants to access their money under certain conditions. Specifically, we’re talking about 401k hardship withdrawals. These conditions exist to a) entice employees to save in their retirement program with the knowledge that they can access it if absolutely necessary, and b) to give employees a source of funds to eliminate certain financial burdens that may arise in life.
401k hardship withdrawals are heavily restricted, though, and carry many caveats. We’ll first give you the details on what is considered a “legitimate” need for a hardship withdrawal and then we’ll cover some of the caveats.
First, what conditions exist that allow us to take a hardship withdrawal?
- The withdrawal of assets is necessary to cover an immediate and heavy financial need
- The money cannot be reasonably obtained from some other source
- The amount of the hardship withdrawal does not exceed the amount of the burden
Okay, for what reasons can I take a hardship withdrawal?
Ah, the $64,000 question.
While each person has their own idea about what a true hardship situation is, the IRS has set forth six very specific reasons:
- Outstanding and non-reimbursable medical expenses. This means that you can take a hardship withdrawal to pay for any medical expenses that are not covered by insurance. To qualify, you will generally need to provide a copy of your explanation of benefits (EOB) that you received from your insurance provider showing what part of your medical are, and are not, covered. This withdrawal can be used to pay for medical expenses related to you, your spouse, or your dependents. By the way…this EXCLUDES any kind of cosmetic surgery.
- Prevention of eviction or foreclosure on a primary residence. If you are faced with the threat of being evicted from your home, or with being foreclosed upon, you can seek a hardship withdrawal in order to make yourself current on your rent or mortgage. If you are facing eviction, you will generally need to provide a letter from your landlord indicating the amount you owe to bring yourself current, and the date that the money is due by to prevent your eviction. The letter must usually be signed and dated by your landlord within the previous 30 to 60 days you request the hardship withdrawal. If you are facing a foreclosure on your primary residence, the same rules apply. The keyword here, however, is primary residence. If you are facing foreclosure on a second home or rental property you cannot seek out help from your 401k in the form of a hardship withdrawal. Sorry.
- Post-Secondary Education Expenses. If you, a spouse, or dependent needs tuition money to pay for classes at an accredited university, you can take a hardship withdrawal for that. This is generally limited to tuition fees and room and board, and lab fees for 12 months in the future. It generally will NOT cover transportation and computer-related expenses. (some plans may have looser rules, so do check). You will need to provide a bill or invoice from the bursar’s office (on school letterhead) with an itemized breakdown of expenses.
- Purchase of primary residence. If you are planning to purchase a home, you can use a hardship withdrawal to cover most of the expenses for the home including down payments, closing costs, and other associated fees. Covering expenses related to actually moving are not permitted. Same with the cost of renovations or decorating. You will generally need to provide a copy of the Good Faith Estimate as well as a signed copy of the purchase agreement. Similar to the foreclosures, you can only take this withdrawals for purchasing your primary home – not a vacation home or rental property.
- Funeral Expenses. If a member of your family passes away, funeral expenses can quickly erode any savings you might have had. If necessary, you can take a 401k hardship withdrawal to cover the expenses of funeral and burial costs. You will need to supply an itemized list of expenses from the funeral home as evidence of your need for the hardship withdrawal.
- Repair of damage to principal residence caused by natural disaster. This was not always an allowable reason for a hardship withdrawal. But the devastation of Hurricane Katrina in 2005 made lawmakers realize that an additional hardship withdrawal rule needed to be added to assist people in any future disasters. (as a side note, when Hurricane Katrina hit, Congress quickly passed a temporary bill that allowed anyone living in zip codes affected by Hurricane Katrina to take hardship withdrawals without penalty). Realize that the term natural disaster is very specific. Generally speaking, a thunderstorm which caused your roof to leak does not constitute damage by natural disaster and would likely not be allowed. If you aren’t sure, check with your employer or provider to determine what the plan is willing to allow.
Note: Credit card receipts are generally not acceptable forms of proof for taking a hardship withdrawal.
Again, these six items are what the IRS deems as hardship needs. Your circumstances may be different. If they are, you should still ask your employer or 401k provider for a hardship withdrawal option. The worst they can do is say ‘no’. If they do, don’t take it personally. They’re just trying to protect themselves in case the IRS comes knocking on their door. Because if they’ve allowed numerous ineligible hardship withdrawals, they are ultimately responsible and could lose the qualified status of their plan.
To go a little further with this, it is also entirely possible that you don’t have to provide any documentation proving the reason for the 401k hardship withdrawal. Some employers have started moving to a “self-certification” method of taking hardship withdrawals, meaning that by signing a 401k hardship withdrawal form, the employee is attesting to the fact that they are taking a legitimate hardship withdrawal (ones that fall within the above parameters). Some employers aren’t comfortable prying into their employees’ lives and they also recognize that most employees are very uncomfortable disclosing their personal troubles with their coworkers and superiors.
Here are a number of things to keep in mind regarding 401k hardship withdrawals:
- Your employer is not required to offer a hardship withdrawal. If they do, they are not required to let you take everything. Many plans limit hardship withdrawals to your employee contributions only. This means that all employer contributions, plus any earnings that the employee contributions have made are not included.
- Generally you are required to exhaust any available plan loans from your account along with any other withdrawals before you can touch a 401k hardship withdrawal. Once you have exhausted those options, you may be eligible for the hardship.
- Hardship withdrawals cannot be rolled over. Once you take it, it’s gone from your account forever. You can’t put it back and you can’t roll it to another account.
- Once you take a hardship withdrawal you are not allowed to make employee deferrals for 6 months. Chances are that if you have a true hardship situation you probably don’t want to contribute anyway, but the lost contributions for a half year, plus the actual withdrawal can set you back tremendously.
- You will pay a 10% early withdrawal penalty if the hardship withdrawal is taken before you turn 59 ½. This can potentially be a huge sum of money. Make sure you absolutely need the withdrawal before you take it.
- When taking a hardship, there is one major exception to the 10% early withdrawal penalty. If you are taking the withdrawal to pay for medical expenses and the expenses exceed 7.5% of your adjusted gross income (AGI) for that year, you may get out of paying the 10% penalty.
- Tax withholding on a hardship withdrawal is not mandatory like it is on all other withdrawals. If you choose, you can elect to have 0% withheld for federal and state taxes. If you do want taxes withheld, however, it has to be a minimum of 10%. This is completely optional, but remember whatever you don’t pay up front, you will pay when you file PLUS your 10% early withdrawal penalty.