The economy is difficult for many people right now, and if you experience a genuine financial hardship, you may be able to tap into your retirement accounts to make a hardship withdrawal from that account. Eligible accounts usually include employer sponsored retirement accounts such as a 401k plan, the Thrift Savings Plan, etc.
However, just because you can make a withdrawal doesn’t mean you should. Like many other retirement savings plans, the 401k is designed for long term savings and accessing retirement funds is usually discouraged.
Let’s take a closer look at a 401k hardship withdrawal and important factors that should be considered before taking this action to resolve a financial hardship.
What qualifies as a hardship withdrawal?
Each person has their own definition of what may qualify as a financial hardship. To make matters less confusing, the IRS provides their own definition of a financial hardship. In order to be eligible for a hardship withdrawal from your 401k, your financial hardship must be the result of one of the following:
- certain medical expenses
- purchase of principal residence
- college tuition or other educational expenses
- pending eviction or foreclosure
- burial or funeral expenses
- expenses related to the repair of primary residence
Other IRS stipulations for a hardship withdrawal include:
- the withdrawal must meed an immediate and heavy need
- the withdrawal must be the only option available to meet the need
- the withdrawal must satisfy the need, amounts in excess of the need not permitted
- the withdrawal cannot come before all non-taxable distributions or loans have been obtained from the 401k
- contributions prohibited for 6 months following the hardship withdrawal
These rules are in place to prevent individuals from taking a hardship withdrawal for purposes other than a true financial hardship.
Benefits of hardship withdrawal
The obvious benefit of a hardship withdrawal is the ability to access your own savings to pay for the expenses that are responsible for your financial hardship. Unlike a 401k loan, hardship withdrawals do not have to be paid back into the account.
Drawbacks of hardship withdrawal
Regardless of the reason behind the withdrawal, the fact remains that you are taking a distribution from your retirement account for purposes other than retirement. Treated as a distribution, the hardship withdrawal is subject to income tax and the 10% early withdrawal penalty if you are not age 59 1/2. Loss of growth opportunity is another negative consequence of tapping into your 401k early.
Factors to consider before making a 401k hardship withdrawal
Hardship withdrawals are permitted by law, however employers are not required by law to include them in your plan. The cost of administering this type of program is often too expensive for small companies working with a limited budget. Check with your plan administrator or human resources department to find out if this option is available to you.
Before considering a hardship withdrawal, carefully consider how this move will impact both your short and long term financial goals. Will the short term benefits of taking money from your retirement account outweigh the long term consequences? As a general rule, tapping into retirement savings should be avoided whenever possible.