403(b) and 401(k) Hardship Withdrawal Rules You Should Know

Many Americans are still feeling the pressure from the economy and a lot of people have turned to their retirement savings as an emergency.  While it isn’t the first place you should turn to if you can’t make ends meet, it’s sometimes one of the only options left for struggling families.

Before you tap into your 401(k) or 403(b), understand that there are certain provisions that are extended to you if you are going through a hardship.  The IRS outlines qualified retirement hardship distributions that need to be met before you can take a hardship distribution.  Generally, the money in your 401(k) or 403(b) is untouchable unless you reach age 59 ½ or terminate employment, but the hardship provision allows early access if it’s a qualified expense.

Note: Your employer does not have to provide hardship provisions within the plan, so be sure to check with your HR department to see if a 401(k) hardship is available.

Who Qualifies for a Hardship Withdrawal

You may qualify for a hardship if you need to cover certain expenses (outlined below.  But first, the IRS requires that you satisfy all other sources first, meaning that you have no other funds or means available to meet the need.

Qualified Expenses for 401k Hardship Distributions

According to the IRS 401(k) Resource Guide, the following needs would qualify as a hardship distribution:

• Certain medical expenses for you or any dependents (including spouse)
• Costs relating to the purchase of your principal residence.
• College tuition and related educational fees and expenses for you or any dependents (including spouse)
• Payments necessary to prevent eviction from, or foreclosure on, a principal residence
• Burial or funeral expenses; and
• Certain expenses for the repair of damage to the employee’s principal residence.

How Much Can I Receive as a Hardship Distribution?

The hardship distribution cannot exceed your documented need, so you won’t be able to take out ‘extra’ to cover anything that you want.  Your qualified retirement plan will most likely require that you show proof of need and will limit your distribution to satisfy that need and no more.

Does a Hardship Distribution Have an IRS Penalty?

Usually, early withdrawals from a qualified retirement plan will result in a 10% penalty if you are under age 59 ½.  You must also include the distribution in your taxable income for the year.

There are, however, exceptions to the 10% penalty, which are listed below.

From IRS Publication 17:

You may not have to pay the 10% additional tax if you are in one of the following situations.

• You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance.
• You are disabled.
• You are the beneficiary of a deceased IRA owner.
• You are receiving distributions in the form of an annuity.
• The distributions are not more than your qualified higher education expenses.
• You use the distributions to buy, build, or rebuild a first home.
• The distribution is due to an IRS levy of the qualified plan.
• The distribution is a qualified reservist distribution.

Hardship Alternatives: Loan from your 401(k)

Ask your employer about alternatives to hardship distributions like a loan from your 401k.  Many retirement plans allow you to borrow from your retirement plan and pay it back over a 5-year period. Generally, you can borrow up to half the value of your account to a maximum of $50,000; whichever is the lesser of the two.

Do Hardship IRA Withdrawals Exist?

The IRS answer: Not Exactly.  With IRAs, you generally have access to your money without showing need for a hardship distribution.  The whole point of a hardship distribution on a 401(k) or 403(b) is to give you access to your funds if you are 59 ½ or younger and meet certain qualifiers.  401(k) and 403(b) plans are very restrictive in terms of early distributions, but IRAs are much more lenient.  In fact, you can usually take an early withdrawal from your IRA without much of a hassle – though it will most likely be considered as taxable income for the year.  If your distribution is for a qualified expense like a first time home purchase or higher education expenses, you may not be subject to the early distribution tax of 10%.

Always check with your employer, tax professional, or financial planner to look for the best solution to your hardship.