Taking Hardship Withdrawals From Retirement Plans

Do you have a 401k or 403b retirement plan at work?

If you do, then you may be able to take out a loan from your retirement plan or make a hardship withdrawal. Plans are not required to offer either option, but offer one or both:

  • Loans: these are temporary withdrawals that must be paid back within five years, with interest. If not paid back within five years, it is treated as a distribution and if the participant is not at least 59.5 years old, then they must pay a 10% penalty on top of income taxes on the withdrawn funds.
  • Hardship withdrawals: these are withdrawals made for specific hardship reasons. The amount withdrawn is subject to income tax and if the participant is not at least 59.5 years old, then they must pay a 10% withdrawal penalty. The amount withdrawn may not exceed the amount needed to satisfy the hardship. For example if you have a $10,000 medical bill you need to pay, you cannot take out more than $10,000.

You may be required to first take a loan before taking a hardship withdrawal.

Current rules

The IRS allows an employee to withdraw money from their employer-sponsored 401k or 403b plan:

  1. To pay for unreimbursed medical expenses for plan participants or their spouses or dependents
  2. To purchase the plan participant’s principal residence, excluding mortgage payments
  3. To pay college tuition and related post-secondary education cots such as room and board for the next 12 months for a plan participant, spouse, depend or child who is no longer a dependent
  4. To make payments to prevent eviction or foreclosure on a mortgage of a principle residence
  5. To pay funeral expenses for plan participants and their spouse, children, dependents, or beneficiary
  6. To pay for repairs to a plan participant’s principal residence if the repairs fall under the IRS’s definition of casualty loss.

For more information: www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions

There is also a requirement that when you make a withdrawal, you have to wait to make any contributions to your retirement plan for six months.  So that means if your employer matches any money that you contribute to your plan each paycheck, then you are not only missing out on the tax benefits of your contributions, but you are also missing out on the money that your employer would have matched!

New rules

Under the latest budget law passed on February 9, 2018, it is now easier to make a hardship withdrawal from employer-sponsored retirement plans.

Beginning in 2019, employees:

  • who make hardship withdrawals are no longer required to stop making contributions to the plan for six months, which allows employees to keep benefitting from an employer match.
  • cannot be required to first take a loan from their plan before making a hardship withdrawal
  • can now withdraw the plan sponsor’s qualified nonelective contributions, qualified matching contributions, and profit-sharing contributions

Taking loans or hardship withdrawals from retirement plans may be useful way for people diagnosed with cancer to find some financial relief. However, it is important to understand how the rules apply to you and to speak with a financial planner or an accountant before making any financial decisions.

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