Everything You Need to Know About 401(k) Hardship Withdrawals

Emergencies happen when you least expect them, and when they do, you may find yourself financially strained to accommodate them. In trying times, you should turn to a savings account or emergency fund to assist with expenses.

In the worst-case scenario, you may need to consider a hardship withdrawal from your 401(k) plan. While it can alleviate stress by providing the funds you need, it should be your last resort.

To learn more about hardship withdrawal eligibility, how to make a withdrawal, and ways to avoid penalty fees, read the information below.

Eligibility for a Hardship Withdrawal

Funds from a 401(k) plan can be withdrawn on an emergency-basis to meet immediate, heavy, and demanding financial needs. Some eligible circumstances noted by the Internal Revenue Service (IRS) include:

  • Medical expenses
  • Burial or funeral expenses
  • Home repairs to a principal residence due to natural disasters
  • COVID-19 related hardships

While withdrawing the funds for an immediate financial need may feel like a loan, there are differences. Hardship withdrawals cannot be paid back over time, and do not accrue interest. When you are ready and eligible, you can start contributing funds back into the account as normal. Another difference is that your employer will require paperwork to prove your hardship, so make sure you contact them before you start withdrawing funds.

How to Make a Hardship Withdrawal

First, determine if you have other assets to draw funds from. If you have a savings account or emergency fund that can accommodate your immediate financial needs, use those. If not, then you will need to contact your employer’s Human Resources (HR) team to learn more about the terms associated with your employer-sponsored 401(k).

If the plan allows for hardship distributions, you will need to provide the paperwork and documentation required to process the request.

Most plans only allow you to withdraw funds that you contributed to the account, so if your employer has a match program, the matched funds may not be accessible for your hardship. Check with your company’s HR team to verify.

It’s important to note that once you make a hardship withdrawal, you may not be able to contribute funds to your account for a period of time. Again, this is something you will want to discuss with your employer to better understand the terms.

Avoiding Penalties

While you may not be able to avoid all taxes on your withdrawal, there are few circumstances that will allow you to avoid some penalties.

If you are withdrawing funds for an eligible hardship, it’s important that you stay within the financial limits for your need. You can only take out what you need for the emergency. Extra funds are not eligible for withdrawal and will face a 10% withdrawal penalty.

Another way you can avoid a penalty is by tapping into other retirement savings accounts first. If you have a Roth IRA, for example, you can withdraw funds without proof of hardship, and you can avoid a tax penalty because the funds were taxed before deposit.

401(k) Loans

Alternatively, you can take out a 401(k) loan, which can be paid back over time. 401(k) loans also sidestep tax and early withdrawal penalties, saving you money while you overcome your hardship. While you will eventually have to repay the loan, you can take out as much as you need for your emergency without worry. The majority of 401(k) plans let you borrow money from your account. A typical plan would allow you to borrow up to 50% of your balance, but not more than $50,000. Use this calculator to help you determine if you should borrow from your account and the potential impact on your retirement savings.

Dealing with hardships can be stressful, especially if you find yourself in a limited financial situation. While assets like a savings account or loan should be your first line of defense against an emergency, sometimes that is not possible or not enough. Having options like a hardship withdrawal can relieve financial stress and free time for you to manage your emergency.

If you are not sure if a hardship withdrawal is right for you, talk with a financial advisor or your employer’s HR team. If you need more information regarding savings, loans, and financial wellness tips, visit the Slavic401k blog.

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