An early distribution from your 401k is typically taxed with a 10% penalty plus income taxes if you’re under the age of 59½. However, the IRS can grant an exemption if the withdrawal is taken due to hardship. You’ll still have to pay income taxes, but you won’t have to pay the 10% penalty.
How long does a hardship withdrawal take?
A 401k hardship withdrawal can take between 7 to 10 business days if you’re receiving the funds through a check, and 3 to 7 business days if you’re receiving the funds through direct deposit.
If your 401k funds are invested in mutual funds, your plan provider will sell the appropriate amount of shares in order to fulfill your withdrawal. Once sold, they’ll issue you a check or direct deposit the funds into your account.
What is a 401k hardship withdrawal?
A 401k hardship withdrawal is an emergency withdrawal of funds from your 401k plan due to an immediate and heavy financial need.
The IRS lists 6 different reasons when a hardship withdrawal is acceptable:
- Costs directly related to the purchase of a principle residence (excluding mortgage payments).
- Post-secondary education expenses (including tuition, room and board expenses, and any education fees like textbooks) for the next 12 months for the employee, employee’s spouse, children, dependents, or beneficiaries.
- Medical care expenses for the employee, employee’s spouse, children, dependents, or beneficiaries.
- Funeral or burial expenses for the employee, employee’s spouse, children, dependents, or beneficiaries.
- Repairs to principle residence due to a casualty loss that would have been tax-deductible under Section 165 of the Internal Revenue Code
- Payments necessary to prevent foreclosure or eviction from principle residence.
While the guidelines to determine what counts as a “hardship” are set by the IRS, your plan provider can add on additional provisions and ultimately decide whether or not to allow such withdrawals. For example, a plan provider can decide that they’ll consider medical and funeral expenses as a hardship withdrawal, but not education expenses.
How to make a 401k hardship withdrawal
To make a hardship withdrawal, request the withdrawal from your 401k plan administrator. You’ll have to provide documents to prove the hardship, which can include medical bills, bank statements, and any invoices.
If your request for a hardship withdrawal is approved, your plan administrator will process the withdrawal and release the funds through a check or direct deposit. Hardship withdrawals cannot be repaid to the plan, like you could with a 401k loan. You also cannot rollover your hardship withdrawal to another retirement plan.
Will I have to pay taxes and penalties?
Penalties: If you’re under the age of 59½, any withdrawals made from your 401k are hit with a 10% early distribution penalty. However, if your withdrawal is accepted as a hardship withdrawal, the 10% penalty can be waived.
Taxes: If you’re withdrawing from a traditional pre-tax 401k plan, you’ll have to pay regular incomes taxes when you withdraw from a 401k, whether it’s a regular withdrawal or a hardship withdrawal. When you take a hardship withdrawal, your plan provider may withhold 20% of the funds to pay taxes on the withdrawal amount. For example, if you request a hardship withdrawal of $50,000 then you’ll only receive $40,000 because 20% of the amount would get withheld.
Is there a limit to how much I can withdraw?
The IRS states that: “The distribution isn’t greater than the amount of the immediate and heavy financial need, including the amounts necessary to pay any taxes resulting from the distribution.”
However, the specific limits for a hardship withdrawal are determined by your plan provider. Some employers will only allow you to withdraw your employee contributions and not your employer match contributions. Some employers will require that you take out a loan before you can access a hardship withdrawal.
Hardship withdrawal vs 401k loan
If your 401k plan offers the option to take a 401k loan, it may be the better path to consider before taking a hardship withdrawal. With a 401k loan, you’re allowed to borrow up to 50% of your account value, up to a maximum of $50,000.
A 401k loan is not subject to the 10% early distribution penalty, is not a taxable event (as long as you repay the loan within the payback deadline), and is generally faster to process than a hardship withdrawal.
You’ll have 5 years to repay the loan, and can get up to 15 years if you use the money to pay for a primary residence. Interest rate is usually prime rate plus one or two percent, and all interest payments go back into your 401k plan.
Also read: 401k Withdrawal Rules & Penalties Explained