Smart 401(k) Investing—Special Features of Your 401(k)
You may be able to withdraw from your 401(k) account to meet the needs of a real financial emergency. The IRS cites a number of circumstances that may qualify as a hardship withdrawal, including:
While the IRS sets certain guidelines, it leaves it to your employer to determine the specific criteria of a hardship withdrawal. For instance, one plan may consider a medical expense to be a hardship, but not payment of college tuition. Even if your plan allows for a hardship withdrawal, you should probably think of it as a last resort. Companies often prohibit contributions for at least six months after taking the withdrawal, and hardship distributions permanently reduce your account balance. In addition, you will have to pay taxes on the amount you withdraw, plus a 10 percent penalty if you are under age 59½.
If you do apply, your plan will probably require you:
You may be expected to withdraw any after-tax dollars you’ve contributed to your 401(k) account, borrow the maximum permitted from the plan, and apply for commercial loans as part of the qualification process.
Finally, your plan administrator may follow up after the withdrawal to verify that you used the money as you indicated you would in your application. And you’ll usually have to wait six months before you can again contribute to your plan.
What Hardship Costs
|Not all plans permit distributions from 401(k) accounts because of hardship. Ask your employer if hardship withdrawals are allowed.|
A hardship withdrawal costs you any future earnings you might accumulate on the amounts you take out of your plan account. In most cases, you will also owe income tax and possibly a 10 percent tax penalty on early distributions on your withdrawal.
You can take hardship withdrawals from either a traditional or Roth 401(k) account, if your employer plan allows them. If you take your withdrawal before age 59½, you must pay an additional 10 percent penalty. The IRS grants several exceptions to the age rule, such as if:
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