What’s a hardship withdrawal?
A hardship withdrawal is a type of qualified distribution that allows you to take money from your retirement plan savings to cover an immediate and serious financial need. The amount you withdraw is limited to what’s necessary to satisfy the financial need. A couple of the benefits of a hardship withdrawal over a loan are that you don’t have to repay a hardship withdrawal and you don’t pay interest, as you would with a loan.
In general, you may be considered to have an immediate financial need for any of the following reasons:
- Medical expenses
- Purchase of a principal residence
- Expenses for certain repairs due to damage to your home
- Post-secondary education costs
- Funeral costs for a family member
Determining your hardship withdrawal amount
Most, but not all, plans have hardship withdrawal provisions built in.
Typically, employee contributions may be eligible when taking a hardship withdrawal. Earnings on those contributions may also be eligible for withdrawal, if the plan permits. Employer contributions may also be used, but they may be subject to different requirements.
Depending on your plan’s rules, you may be required to take any available loan amounts, prior to taking a hardship.
If you’re experiencing a financial hardship, you should check with your employer or plan sponsor to determine whether you qualify based on your plan’s specific terms and/or your circumstances.
Are there penalties for taking a hardship withdrawal?
Hardship withdrawals are subject to income tax, and, if you’re younger than age 59½, you’ll pay a 10% early withdrawal penalty. And unlike taking a loan from your plan, you don’t have to repay a hardship withdrawal back to your retirement plan. This means taking a hardship withdrawal will permanently reduce your retirement plan balance.¹
Prior to January 1, 2020, participants who took a hardship withdrawal were prohibited from contributing to their retirement plan for six months. This rule was eliminated with the passing of new regulations on 401(k) hardship distributions. This means that you’re free to continue to save for your retirement through your retirement savings plan, even right after you’ve taken a hardship withdrawal.
Plan for the unexpected and expected
Emergencies happen, and it’s best to have a plan for when unexpected expenses arise. Here are some options to consider, so that you don’t need to take money from your retirement savings:
- Start an emergency savings fund
Try to build up emergency savings to cover at least six months of essential expenses, in case of job loss, illness, or other unforeseen events.
- Plan for your child’s college
If you have children who plan to go to college, think about starting an education fund when they’re young, so the contributions have time to grow. If they’re ready to go to college, look into financial aid or scholarships that can help reduce financial hardships.
Planning ahead can not only help you be more prepared and make an unexpected emergency less stressful, it can also keep you from prematurely using the money you’ve set aside for your retirement.
1 “Retirement Plans FAQs regarding Hardship Distributions,” IRS, May 2022.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.