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401k Hardship Withdrawals - Rules and Eligibility

Rules and Eligibility for 401k Hardship Withdrawals

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Under IRS rules, when your employer set up their 401k plan they decided if they would allow 401k hardship withdrawals. 401k plans do not have to allow hardship withdrawals, and if your employer did not elect this option in their 401k plan document, then regardless of how dire your circumstances they cannot change their mind and make an exception for you without redoing the 401k plan document, which can take many months.

To find out if your plan allows for a 401k hardship withdrawal you will need to talk to your 401k plan administrator, which might be someone in the human resources or benefits department, or you can call the phone number on your 401k plan statement.

401k Hardship Criteria

If your 401k plan allows for hardship withdrawals if would be for one of the six reasons below:

  • Unexpected medical expenses
  • Costs relating to the purchase of a home
  • Tuition and related educational fees and expenses
  • Payments necessary to prevent eviction from, or foreclosure on, your home
  • Burial or funeral expenses
  • Expenses for the repair of damage to your home

Proof of Hardship

To qualify as a hardship, you will need to explain your situation to your 401k plan administrator. Most of the time they can determine if they think your circumstances qualify as a hardship, but some 401k plans may require that some form of documentation be presented. Ask your 401k plan provider what they require as proof of a hardship.

If you have other resources that can be used to meet your financial need than you are expected to use those assets first and use a 401k hardship withdrawal only if it is your last available option.

Before Taking a 401k Hardship Withdrawal

Many people do not know that 401k money is protected from creditors and protected from bankruptcy. If you are experiencing financial hardship and think you may end up filing bankruptcy do not cash out your 401k plan. Your creditors and the bankruptcy court cannot take your 401k plan money.

It may be better to borrow money rather than take a 401k hardship withdrawal. Too many people cash out of a 401k plan or take a hardship withdrawal to pay medical expenses when their 401k money would be protected from these creditors.

Try working out a payment plan with a creditor before you touch your 401k plan money.

After You Take a 401k Hardship Withdrawal

For six months after your take a 401k hardship withdrawal you will not be allowed to make contributions to your 401k plan.

Difference Between a 401k Hardship Withdrawal and a 401k Loan

When you borrow money from your 401k plan you can pay it back over five years, and the interest you pay goes back into your account. At the time you take a 401k plan loan, you will not pay taxes on the amount you borrow. If you do not pay back the full amount you borrowed from your 401k plan according to the repayment plan then the amount will become a taxable distribution to you and may also be subject to a 10% penalty tax if you are not yet age 59 1/2.

When you take a 401k hardship withdrawal you are not allowed to pay back the amount withdrawn. In addition you will pay taxes on the amount you withdraw in the year you withdraw it.

Because of these differences a 401k plan loan allows more flexibility than a 401k plan hardship withdrawal.

Taxes on a 401k Hardship Withdrawal

You will pay taxes on the amount you take out in the form of a 401k hardship withdrawal. In addition to regular income taxes, you will likely pay a 10% penalty tax. You may be able to avoid the 10% penalty tax if you meet one of the following exceptions:

  • You are disabled.
  • You medical debt that exceeds 7.5 percent of your adjusted gross income – however, because 401k assets are protected from creditors it may not be in your best interest to use a 401k hardship withdrawal to pay these medical expenses.
  • You are required by court order to give the money to your divorced spouse, a child, or a dependent.

Learn more about 401k hardship distributions:

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  6. 401k Hardship Withdrawals - Rules and Eligibility

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