Hardship Withdrawals from 401(k) Plans

In these challenging economic times, you may be considering taking a hardship withdrawal from your 401(k) plan. Here are some points to think about before you pull the trigger.

What is a hardship withdrawal?

When discussing 401(k) hardship withdrawals, we’re generally talking about withdrawing your own elective contributions to the plan. This means your pretax contributions and your Roth contributions to the plan. A hardship withdrawal generally can’t include any earnings on your contributions.

In order to qualify for a hardship withdrawal, you have to have an immediate and heavy financial need, and your withdrawal can’t exceed the amount necessary to meet that financial need (including any taxes and penalties resulting from the hardship withdrawal itself). But there’s an important restriction: you can’t take a hardship withdrawal at all until you’ve taken all other non-hardship distributions and loans available to you from the 401(k) plan, and any other deferred compensation plans maintained by your employer.

Plans have a number of ways of administering the hardship withdrawal rules, but most rely on a “safe harbor” rule that automatically treats the following as constituting an immediate and heavy financial need:

• Medical care expenses for you, your spouse and dependents, and your plan beneficiary

• Costs directly related to the purchase of your principal residence (but not mortgage payments)

• Payment of tuition, fees, and room and board expenses for up to the next 12 months of post-secondary education for you, your spouse and dependents, and your plan beneficiary

• Payments necessary to prevent eviction from your principal residence or foreclosure of your mortgage

• Payments of burial and funeral expenses for your parents, spouse and dependents, and your plan beneficiary • Expenses to repair casualty damages to your principal residence

Why you should think twice …

In general, you should take a hardship withdrawal from your 401(k) plan only as a last resort, for the following reasons:

• Hardship distributions are includible in your gross income except to the extent they consist of your own after-tax (including Roth) contributions to the plan.

• The taxable portion of your withdrawal will be subject to a 10% early distribution penalty unless you’re 59½ or another exception applies.

• If your plan uses the safe harbor rule described earlier, when you take a hardship withdrawal, you’ll be suspended from participating in the plan (and any other elective plan maintained by your employer) for at least six months.

• Unlike plan loans, you generally can’t pay a hardship withdrawal back to the plan. A hardship distribution permanently reduces your account balance, reducing the amount that can work for you on a taxfavored basis until you retire.

• You can’t roll a hardship distribution over to an IRA or another employer plan.

And keep in mind …

A 401(k) plan doesn’t have to allow hardship withdrawals at all. And if it does, the plan may limit the reasons that qualify as a hardship, or may limit the amount you can withdraw. Some plans may not permit hardship withdrawals that are based on the need of your plan beneficiary. And in some cases, the plan may require that you prove you have no other resources available to meet your hardship need.

Your 401(k) plan may also permit withdrawals of other amounts in your account–for example, your employer’s contributions to the plan– but these withdrawals may be subject to different rules.

You need to review your specific plan’s terms to see what options are available to you. Your plan’s withdrawal rules should be clearly described in the plan’s summary plan description (SPD). If you don’t have one, request it from your plan administrator, and discuss your options with your financial professional.

Unlike plan loans, you generally can’t pay a hardship withdrawal back to the plan. A hardship distribution permanently reduces your account balance, reducing the amount that can work for you on a tax-favored basis until you retire.

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