Are you experiencing financial challenges? Do you prefer not to use a credit card or take out a personal loan to access the funds you need? A 401(k)hardship withdrawal could be a viable option for you. But first, you should be aware of how they work, along with any rules and limits that may apply.
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What is a 401(k) Hardship Withdrawal?
A 401(k) hardship withdrawal occurs when you draw funds from your 401(k) account. But unlike a 401(k) loan, you won’t repay the amount you pull out over time with interest. Instead, you’ll be subject to federal income tax and an early withdrawal penalty if you’re not yet at least 59 ½ years of age (unless you can prove that the funds were used for a qualified hardship).
When a 401(k) Hardship Withdrawal Makes Sense
A 401(k) hardship withdrawal may be sensible and allowable by the IRS in these circumstances:
Select medical expenses could make you eligible for a 401(k) hardship withdrawal.
Burial or Funeral Costs
Another viable reason to take a 401(k) hardship withdrawal is to cover the funeral and burial costs of a close loved one.
Purchasing Principal Residence
You could also be eligible for a 401(k) hardship withdrawal if you’re planning to purchase a home that will be used as your principal residence and need funds for the down payment.
If you incur higher education tuition or related fees in the next 12 months, you might qualify for a 401(k) hardship withdrawal.
Falling behind on your rent or mortgage payments is never fun, but a 401(k) hardship withdrawal could possibly provide the financial assistance you need to get back on track.
Home Repair After a Natural Disaster
A natural disaster that causes substantial damage to your home can also be challenging to recover from, particularly if your insurance company isn’t cooperating. In the meantime, you may be eligible to take a 401(k) hardship withdrawal to start making costly repairs that would stretch your wallet too thin if you covered them out of pocket.
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401(k) Hardship Withdrawal Rules and Limits
Your employer sets the rules for 401(k) hardship withdrawals. In some cases, they’re prohibited until you’ve borrowed the maximum amount from your 401(k). And some employers require documentation from the employee to prove that no other assets are available to cover the financial emergency.
With regards to withdrawal limits, that’s also at the discretion of the employer. Most will permit you to pull out the amount you need – no more and no less.
Are There Consequences in Taking a 401(k) Hardship Withdrawal?
It depends on your age when you pull the funds. If you’re under 59 ½, you’ll pay federal income tax and a 10 percent early withdrawal penalty to the IRS on the amount you withdraw.
Furthermore, you should keep in mind that you’ll be taking away from your nest egg. The funds you pull out can no longer grow tax-deferred or benefit from the power of compounding interest. And if you owe creditors, these funds could also be at risk for seizure as they are no longer protected under your 401(k)
Is There a Way to Minimize Taxes and Avoid Penalties?
Yes, you can opt for a 401(k) loan instead. Just make sure it’s paid off before you leave your employer, or you’ll pay the early withdrawal penalty of 10 percent and federal income tax. Another option is to wait until you’re 59 ½ years of age to take penalty-free withdrawals, assuming you’re still employed.
If you decide to retire early, the IRS allows penalty-free distributions if you’re at least 55 years of age (or 50 for firefighters, police officers and other public safety workers).
Seek Professional Help
Whether you’re planning to take a 401(k) hardship withdrawal or have already done so, the team at Larson Tax Relief can help you explore ways to minimize taxes and avoid penalties.
The BBB-accredited firm, which employs 18 Enrolled Agents, also has over 15 years of experience tailoring customized resolutions for people and businesses with IRS and state tax problems. If you owe over $25,000 in back taxes and you’re looking to save time, money, or the added stress that comes with dealing with federal and state tax authorities, consider getting a free consultation.
Simply fill out the brief questionnaire found here to get started. A tax expert from the Larson team will reach out to you shortly to discuss your unique tax situation, related issues and other concerns you may have.