401k Hardship Withdrawal

As quite a few of you must be knowing, the 401k or 401(k) is a retirement savings plan. This is basically for the financial security of an individual (post retirement) who is employed. It is primarily funded through pre tax payroll deductions. Sometimes, what happens is that an individual can get into a financial emergency and there is no option other than the 401k. In that case that person goes for a 401k hardship withdrawal. Now, all the dealings related to this, akin to Roth IRA plan are governed by the IRS.

Rules for 401k Hardship Withdrawal

A number of aspects are involved in the withdrawals from 401k. The conditions wherein you can apply for early withdrawal from 401k is the most important part of such a withdrawal. These conditions are -

• Purchase of principal residence
• Repairs of primary residences
• Funeral expenses
• Medical bills which have not been reimbursed.
• College expenses of the employee's spouse, dependents or the employee himself.
• Prevention of a Foreclosure

Now even if these conditions make a 401k withdrawal inevitable, there are some more criteria which have to be met. For instance, the applicant or the employee can go for the withdrawal only if no other source of finance is left. Or must have first received all non-taxable distributions or loans you are eligible for and available to you under 401k. Moreover for six months after your withdrawal date, you cannot contribute to the account. Further, you are not allowed to withdraw more than the amount you are going to need. All these rules and criteria are laid down by the IRS. However, all the 401k plans do not offer such hardship withdrawals, so you need to check whether the plan you have allows you to do so. In some plans, with elective coverage, hardship withdrawals are permitted though within very stringent rules. You also would like to know about when will the penalty on the withdrawal be applicable and when it wouldn't be.

Penalty for 401k Hardship Withdrawal

The mantra of penalty is simple. If the person withdrawing money is 59.5 years of age at the time of distribution, he will be needed to pay a 10% early withdrawal penalty on the income tax return during the year end. For reporting an IRS hardship withdrawal, an individual has to use an IRS form -5239 for calculation of the penalty and then mention it on the form 1040 tax return. Primarily this penalty on 401k withdrawal is imposed so that people do not consume their retirement savings and fritter away the tax advantages 401k plan has to offer. There is however, an option where in you can have a penalty free withdrawal. It can be made under section 72(t) of the Internal Revenue Code. Under this, you will not need to pay a withdrawal penalty, though the applicable income taxes prevail. There are a few cases too, where there can be no penalty, for instance, if the person is laid off or quits in the year when he will turn 55 or even after. Or if the person sustains permanent disability.

Taxes on 401k Hardship Withdrawal

Hardship withdrawal may not be a great idea, given its tax related ramifications. To start off, the amount a person withdraws, there will be a tax on it. To give you an example, if the withdrawal amount is over $200, then, around 20% federal income tax withholding will be cut prior to that person receiving the money. This is in addition to any applicable local and state tax withholdings. So generally increased taxes in the year of the withdrawal and less money when an individual retires, compels individuals to think before they opt for such a withdrawal.

Financial experts say unless it is absolutely necessary and there is no other option left, people should avoid hardship withdrawal. The reason being, long-term financial consequences of the withdrawal. That's it! Hope this was useful!