401k Hardship Withdrawal Rules

2010 January 7
by Kyle Bumpus
from → 401k/IRA

Congress, in their infinite wisdom, decided to throw a bone to us little people when they wrote the 401k hardship withdrawal rules into the tax code.  401k plans, like IRAs (both Roth and Traditional), are subject to a 10% early withdrawal penalty when you withdraw money before age 59 1/2.  You can choose to roll over your 401k into an IRA, but it’s still locked up until you reach retirement age (unless you qualify for certain early withdrawal exemptions or take substantially equal periodic payments, but I digress).  Also, while hardship withdrawals are allowed under the law, there is no rule saying your plan administrator must allow them.

401k Hardship Withdrawal Rules

401k hardship withdrawals are allowed only under very specific circumstances, and your and the IRS’s definition of “hardship” may be very different.  There are five overriding 401k hardship withdrawal rules:

  1. The withdrawal is due to an immediate and severe financial need – You can’t take a hardship withdrawal in anticipation of some emergency 9 months down the line.  Qualifying needs will be discussed below.
  2. The withdrawal must be a last resort – You must have no other funds available to fulfill the need.  For example, if you have $10,000 sitting in a bank somewhere, the hardship withdrawal will be disallowed.  It must truly be your last resort.
  3. You must only withdrawal what you need – If an emergency medical procedure costs $2,000, for example, you are only allowed to withdraw $2,000.  Any amount over that will be subject to penalty.
  4. You must have exhausted all taxable loan options – If your plan administrator allows borrowing against your 401k (which is bad idea), for example, you must have exhausted that line of credit before being eligible for a hardship withdrawal.
  5. You can’t contribute to your 401k for 6 months after the hardship withdrawal – I suppose Uncle Sam believes if you can afford to start contributing again so soon, you didn’t really need the hardship withdrawal to begin with.

Qualifying Hardship Withdrawal Expenses

Some examples of expenses qualifying for a hardship withdrawal, assuming the conditions above are met, include…

  • Non-reimbursable medical expenses for you or your immediate family (as well as your dependents)
  • Purchase of a home for first-time home buyers (IRA’s have much laxer rules for this)
  • Higher education costs (consider opening an education IRA instead)
  • Money to pay your mortgage in an attempt to avoid foreclosure (you might consider a short sale instead)
  • Home repair costs
  • Funeral costs

Uncle Sam goes out of his way to make taking a hardship withdrawal as difficult as possible, and for good reason.  Practically any other option will be better in the end.  Still, it’s comforting to know the money is there in times of desperation.

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One Response
  1. 2011 February 5
    Sumar permalink

    Great article on 401k hardship rules. The final step you must meet to be eligible to make a successful withdrawal is the i) proof of need and ii) self authorization.

    i) Proof of Need: With this, you must disclose your finances to your employer and prove the financial hardship you are facing is legitimate & you have no other sources of funding. This method is NOT very popular with employers because they aren’t interested in knowing about their employees’ personal lives.
    Source: http://www.401k-withdrawal-rules.com

    ii) Self Authorization: With this method, you are not allowed to make 401k contributions to your plan for the next 6 months after you take a hardship withdrawal. With this, you do NOT have to disclose your finances to your employer. Think of the 6 month ban as a direct punishment for taking the withdrawal, you will obviously think deep before taking the withdrawal in such a case.

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