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The following is a post by MPFJ staff writer, Toi Williams, who is a professional personal finance blogger from Fine Tuned Finances. She has backgrounds in personal finance, sales, and real estate.
Your 401(k) plan is intended to provide for you during your retirement years, but there may be times where the money in your 401(k) plan is needed for other expenses.
There are not many good reasons to tap into your nest egg, but when a good reason arises, it is important to know how you can obtain the money that you need. Although there are various ways to borrow from or access the money in your 401(k) account, each method has benefits and consequences that you should be aware of.
When you have no other viable options to get the money that you need, you may want to consider a 401(k) hardship withdrawal.
What Is A 401(k) Hardship Withdrawal?
A 401(k) hardship withdrawal is a distribution from a 401(k) plan based on an immediate, costly, financial need by the employee, their spouse, or their dependent. The amount obtained through the withdrawal must be the amount necessary to satisfy the immediate financial need. Because they are not required by the federal government, not all plans allow hardship withdrawals. So, you will need to read the information for your plan to see if these withdrawals will be allowed.
What Circumstances Are Necessary For The Withdrawal?
Any 401(k) plan that allows hardship withdrawals must provide applicants with the specific criteria that will be used to make a hardship determination. The plan may provide for some types of hardships, but not others, and require some sort of documentation to determine the existence of a need and how much money is necessary to meet that need. The plan must use nondiscriminatory and objective standards to make these determinations.
There are certain circumstances that may constitute the costly, immediate financial need required to obtain a 401(k) hardship withdrawal. Certain types of medical expenses qualify as well as burial or funeral expenses. Costs related to the purchase of a principal residence or to prevent foreclosure on a principal residence also typically qualify. Tuition and other related educational fees may be included in the list of qualifying needs as well as expenses to repair significant damage to their primary home. Expenses to purchase furniture, electronics, or vehicles are generally not included.
How Much Money Can Be Withdrawn?
The amount received through a hardship withdrawal cannot exceed the amount needed to satisfy the immediate financial need of the account owner. That amount can include any taxes or penalty fees that result from obtaining the hardship withdrawal. The amount withdrawn cannot be more than the account holder has contributed to the plan up to that point. Earnings, qualified non-elective contributions, and qualified matching contributions cannot be withdrawn under a hardship withdrawal unless there is a specific clause in the plan’s terms and conditions allowing this. Regular matching contributions and profit sharing contributions may or may not be withdrawn depending on the plan used.
What Documentation Is Needed?
The plan that you are obtaining the hardship withdrawal from will specify the type and amount of information needed to demonstrate hardship and qualify for the withdrawal. In some cases, an inquiry into the employee’s financial status is not required and the employer may rely on the employee’s representation that they are experiencing an immediate and costly financial need that cannot be relieved with other resources. In other cases, the account holder must demonstrate that they cannot satisfy the financial need through reimbursement or compensation by insurance, by liquidating their assets, by borrowing from a bank or lending institution, by stopping contributions under the plan, or by obtaining a loan against the plan.
Denial Of Hardship Withdrawals
The owner of the 401(k) account will not be allowed to take a hardship withdrawal if the person has other resources available that will allow them to meet the financial need. These available resources also include the assets of the owner’s spouse and their minor children. For example, a vacation home in the name of the owner’s spouse would be considered a resource under the hardship withdrawal rules. The owner of the 401(k) account must also exhaust all available 401(k) loan options before a hardship withdrawal will be permitted. The employee must first use any available distributions or loans allowed under the plan and any other plan maintained by their employer.
The Consequences Of Obtaining A Hardship Withdrawal
401(k) hardship withdrawals are subject to a penalty fee for withdrawing money from the account before you reach retirement age. This penalty is generally 10% of the amount of the hardship withdrawal. This fee is generally taken from the amount that is going to be disbursed from the plan, so it is important to take the amount of the fee into consideration when determining the amount of money that you need to handle the financial issue that has arisen.
Once the owner of the 401(k) account has received a hardship withdrawal, they are prohibited from making contributions to the plan for a minimum of six months after they receive the withdrawn funds. This includes all elective and employee contributions to the plan or any other plan available from their employer. The amount withdrawn under the hardship withdrawal cannot be returned to the account, permanently reducing the balance of the account.
There may also be consequences when it is time to file your taxes. You may have to pay additional taxes because the withdrawal is considered an early distribution of elective contributions and will be included in your gross income. Depending on the amount of the hardship withdrawal, this can increase your gross income substantially and subject you to a higher income tax bracket.
How about you all? Have you considered or gotten a 401(k) hardship loan? Did it provide you with the financial help that you needed?
Share your experiences by commenting below!
***Photo courtesy of http://upload.wikimedia.org/wikipedia/commons/a/a2/US_Dollar_banknotes.jpg