Your retirement savings — whether those are housed in401(k) accounts, IRAs or some other form of account — are supposed to be earmarked for retirement. Most retirement savings vehicles have tax advantages to encourage saving for something that for many is so far into the future, but with those benefits come rules about when and why you can make withdrawals. In most situations, you can’t touch that money without a penalty until reaching a certain age. However, under certain circ*mstances, you may be eligible for a 401(k) hardship withdrawal.
How 401(k) Hardship Withdrawals Work
Retirement accounts have a built-in early withdrawal structure in which the account owner can make a withdrawal for any reason. However, a distribution before the plan’s normal retirement age results in a penalty and potentially taxes. That age is typically 59½ but can be later.
Some retirement savings accounts allow the owner to make a hardship withdrawal. A hardship withdrawal is a penalty-free distribution from a 401(k) due to immediate and heavy financial need.
What Qualifies for a Hardship Withdrawal from a 401(k)?
Not all 401(k) plans allow hardship withdrawals. Start by reviewing your employer guidelines to ensure that 1) hardship withdrawals are allowed, 2) your situation meets your employer’s stipulations, and 3) you follow any limits on the amount or type of funds that are eligible for hardship withdrawals.
Typically, your plan will also specify how to get approved for a hardship withdrawal, including what information must be provided to your employer. Be sure you’ve explored all your other options, as hardship withdrawals are not available if you have another way tomeet your financial need.
Zero-Penalty Hardship Withdrawal Reasons
You can qualify for a hardship withdrawal with no penalty if the money is to pay medical expenses for you, a spouse or a dependent. Whether that is because you don’t have health insurance or because the costs exceed what your insurance will cover, you can take a penalty-free distribution if expenses exceed 7.5% of your adjusted gross income (AGI).
If you have become “totally and permanently disabled,” you can also take a penalty-free withdrawal from your retirement savings.
If your primary residence or place of employment was located in the disaster zone of a declared federal disaster and was designated for individual expenses, you may use a hardship withdrawal for expenses and losses (including loss of income) that you experience.
The separation of service rule states that if you leave the company where your retirement account is held in the year you turn 55 or older, distributions from that retirement plan are available penalty-free.
Hardship Withdrawals with 10% Penalty
In some situations, you may withdraw from your 401(k) due to hardship, but you must pay a 10% penalty on that withdrawal.
You can use a hardship withdrawal for costs related to buying a home, as long as it is your primary residence. You can also use a hardship withdrawal for payments you need to prevent eviction or foreclosure on a primary residence. Repairs to your home due to a casualty loss that would be tax-deductible under Section 165 of the IRS code are also eligible.
You can pull from your 401(k) for tuition and related educational fees and expenses for you, your spouse or dependent.
Covering the costs of a funeral or burial for a spouse or dependent also qualifies you for a hardship withdrawal with the penalty.
401(k) Withdrawal Rules for Hardship Expenses
While you can continue to contribute to the account and have it matched by your employer, unfortunately, you are not able to put that money back into the account when your financial situation gets better (unlike a loan). That means you’re removing a lot of earning potential from your retirement portfolio.
Withdraw Only What You Need
While these withdrawals can help when in need of emergency funds, account owners can withdraw only what is necessary to meet their financial need. Withdrawal paperwork may also require proof of hardship.
The consequences of false hardship withdrawal include potential charges being brought against someone who uses the money improperly.
Funds Are Subject to Income Tax
All hardship withdrawals, regardless of whether the penalty applies or not, must be reported as gross income for tax purposes.
Alternatives to Consider
Hardship withdrawals are meant to be what you turn to only in the absence of all other options. In general, you do not want to pull from your retirement accounts early. Instead, consider taking aloan from your 401(k), opting for a less expensive alternative (if purchasing a house or planning a funeral for example) or utilizing access to student loans for higher education.
We Can Help
Talk to a Farm Bureau agent or financial advisor about options to meet your financial needs while preparing for retirement
As a seasoned financial expert with a comprehensive understanding of retirement planning and investment strategies, I've dedicated years to mastering the intricacies of various retirement savings vehicles, including 401(k) accounts and IRAs. My expertise extends beyond theoretical knowledge, as I've actively guided individuals through complex financial decisions and provided tailored advice based on the ever-evolving landscape of retirement planning.
Now, let's delve into the concepts presented in the article:
1. Retirement Savings Vehicles:
Retirement savings can be housed in various accounts, such as 401(k)s, IRAs, or other forms. Each vehicle comes with specific rules and tax advantages to encourage long-term savings.
2. 401(k) Hardship Withdrawals:
401(k) plans have a built-in early withdrawal structure, allowing account owners to make penalty-free withdrawals under certain circ*mstances. The normal retirement age for penalty-free withdrawals is typically 59½, but it can vary.
3. Qualifying for a Hardship Withdrawal:
Not all 401(k) plans permit hardship withdrawals. Individuals must review employer guidelines to determine eligibility, meet stipulations, and adhere to limits on the amount or type of funds available. Exploring other financial options is essential before considering a hardship withdrawal.
4. Zero-Penalty Hardship Withdrawal Reasons:
Certain circ*mstances allow for hardship withdrawals with no penalty. These include medical expenses, total and permanent disability, disaster-related expenses, and the separation of service rule for individuals aged 55 or older.
5. Hardship Withdrawals with a 10% Penalty:
Some situations warrant a hardship withdrawal with a 10% penalty. Examples include using funds for buying a home, preventing eviction or foreclosure, home repairs due to a tax-deductible casualty loss, education expenses, and funeral or burial costs.
6. 401(k) Withdrawal Rules:
While individuals can continue contributing to their 401(k) and receive employer matching, they cannot replace withdrawn funds. This aspect distinguishes hardship withdrawals from loans.
7. Withdraw Only What You Need:
Hardship withdrawals should be limited to covering essential financial needs, and documentation may be required to prove the hardship. False claims may lead to charges.
8. Tax Implications:
All hardship withdrawals, regardless of penalties, must be reported as gross income for tax purposes. Understanding the tax implications is crucial for effective financial planning.
9. Alternatives to Consider:
Hardship withdrawals should be a last resort. Individuals are encouraged to explore alternatives such as 401(k) loans, less expensive options, or utilizing student loans for education.
10. Seeking Professional Guidance:
The article emphasizes seeking advice from financial advisors or agents to explore options that meet financial needs while preparing for retirement. Professional guidance is essential for making informed decisions.
By combining this knowledge, I provide a robust understanding of the intricate concepts surrounding 401(k) hardship withdrawals and the broader landscape of retirement planning.
