Hardship Distributions from 401(k)s Carry a Hefty Cost

If you have a retirement plan where you work, that plan might allow you to take a distribution from it if you are experiencing financial hardship. Employer retirement plans are not required to provide for hardship distributions, so make sure to check with the plan administrator. Here is IRS FAQs regarding retirement plan hardship distributions.

Often times, retirement plans that allow you to save money from your paycheck and deposit it into the plan (known as employee salary deferral contributions) allow hardship distributions. These plans include 401(k) plans.

Under IRS rules, a hardship withdrawal must be for an immediate and heavy financial need and because you have no other financial resources. If your 401(k) plan does allow hardship distributions, it must state the specific criteria to determine what is considered a hardship. For example, your plan might allow a hardship distribution but only for certain expenses, such as funeral or medical expenses or to prevent eviction.

You won’t be able to take out your entire 401(k) balance: there are limits. For example, many plans will only allow you to take out the amount you put in as a salary deferral contribution.

One of the biggest problems of taking a hardship distribution is that it is taxable to you. To make matters worse, it’s also subject to an additional 10% early distribution penalty if you’re younger than age 59 ½. And you won’t be able to avoid the tax by rolling the funds over to an IRA because hardship withdrawals are not eligible for rollover.

Another problem is that, unlike plan loans, hardship distributions are not allowed to be repaid to the plan. So, a hardship distribution permanently reduces your balance under the plan.

So between the income taxes that you’ll owe on the distribution (and maybe even a 10% penalty), plus the permanent reduction in your retirement account balance, hardship distributions are very costly.

-By Joe Cicchinelli and Jared Trexler

Posted in: 10 percent penalty,401(k),Ed Slott,ed slott ira,ed slott retirement,financial,financial advisor,hardship distribution,IRAs,joe cicchinelli,Retirement,Tax Planning,taxes