What Constitutes a 401(k) Hardship Withdrawal

What qualifies for a 401(k) hardship withdrawal?

A hardship withdrawal may be available when a plan permits it and a participant has an immediate and heavy financial need. The amount is generally limited to what is necessary to meet that need. Qualifying expenses and documentation requirements depend on federal rules and the plan’s terms.

A large medical bill, an eviction notice or damage to your home can leave you looking for money quickly. If you have a 401(k), a hardship withdrawal may appear to be an option. The first step is to find out whether your plan allows one and whether your expense qualifies under its rules. A financial hardship in everyday conversation does not automatically meet the retirement plan definition.

Taking a withdrawal can affect your retirement savings, but that does not mean it is never appropriate. When you face an immediate expense, getting a clear picture of the amount you need and the options available can help you make an informed decision.

Start with your plan’s hardship rules

A hardship distribution is a withdrawal that a plan may permit when a participant has an immediate and heavy financial need. Federal rules allow 401(k) plans to offer hardship distributions, but plans are not required to do so. A plan that offers them may limit the types of expenses or the sources of account money available for withdrawal.

Ask your recordkeeper or plan administrator for the summary plan description and the current distribution process. The plan determines which eligible reasons it recognizes and what documentation or certification it requires. Do not assume that a coworker’s experience under another plan establishes what is available in yours.

Understand the two conditions

The need must be immediate and heavy, and the distribution generally cannot exceed the amount necessary to satisfy it. The amount may include taxes and penalties reasonably expected to result from the withdrawal. The plan also applies rules for determining whether the need can be met from other reasonably available resources.

Imagine a participant has an eligible $6,000 medical expense after insurance. If the plan permits medical hardships, the participant can ask the administrator how much is available and whether the request can include reasonably anticipated tax costs. This example does not establish that every medical bill qualifies or that a particular request will be approved.

Which expenses may qualify?

IRS rules identify certain expenses that are treated as immediate and heavy financial needs. Each category has specific conditions, and a plan can cover fewer categories.

For example, a plan may permit a hardship for an eligible home purchase but not for tuition. Ordinary mortgage payments are not included in the home-purchase category, although payments needed to prevent foreclosure may qualify under a separate category if the plan permits it. Ask which expense category applies before assuming the money is available.

A foreseeable expense can still qualify. On the other hand, a consumer purchase does not become a qualifying hardship simply because paying for it would be difficult. Repairs and disaster expenses have specific requirements, so a broken appliance or furnace should not be assumed to qualify without checking the applicable rules and the plan.

What will the withdrawal cost?

Previously untaxed amounts in a hardship distribution generally count as taxable income. If you are under age 59½, the taxable portion may also be subject to an additional 10% tax unless an exception applies. A hardship itself is not automatically an exception. Roth amounts have different rules, so ask about the tax treatment of the actual account source and speak with a tax professional.

The distribution may also reduce the money available for retirement and the future investment returns that money might have earned. A hardship distribution generally cannot be rolled over to another retirement account or repaid to the plan. Those longer-term consequences belong in the decision alongside the immediate expense.

Review alternatives and plan procedures

Ask whether insurance, a payment arrangement or other resources could cover some of the cost. A plan loan or a separate emergency personal expense distribution may be available in some plans and circumstances, but each has its own eligibility requirements and consequences. Do not assume a loan is required before a hardship withdrawal or that another distribution is automatically tax-free.

Some plans allow a participant to certify certain facts about the need and available resources. Ask what evidence or certification your plan requires. Federal rules no longer require a six-month suspension of elective contributions following a hardship distribution; confirm how the current plan handles your ongoing contributions.

Before submitting a request, write down the amount needed, the expected timing and the questions you have about taxes and documentation. Your plan administrator can explain the plan’s process, and a tax professional can help you assess the tax consequences. For related education, visit McClone’s Learning Center.

Securities offered through LPL Financial, a Registered Broker Dealer, Member FINRA/SIPC. Investment advice offered through Gateway Wealth Partners, LLC, a registered investment advisor. Gateway Wealth Partners, LLC, McClone Retirement Advisors and LPL Financial are separate entities. TAX AND LEGAL DISCLAIMER: McClone and its affiliates do not provide tax, legal or accounting advice. Any material prepared is for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and/or accounting advisors before engaging in any transactions.