The familiar concept of 401(k) savings goes something like this: we working folks can tuck away money for our future retirement, possibly take advantage of an employer’s matching contribution, and likely enjoy long-term growth in a tax-advantaged account.
By definition, 401(k)s and IRAs are meant to be savings we enjoy during retirement. Consequently, one of the most popular “birthdays” in the financial planning world is age 59.5, the magic age at which the IRS deems us mature enough to withdraw from our retirement accounts. Should we dip into our retirement savings before that age, generally a 10% early withdrawal penalty will be due in addition to taxes (Roth IRAs are a little different. No taxes or penalties apply to the early withdrawal of contributions, but they may apply to the early withdrawal of earnings.).
But what if life gets choppy, and we need to access some retirement money before age 59.5? We hope such a scenario never comes up for you and your family! However, if a hardship were to occur during your working years, the IRS has exceptions to the 10% early withdrawal penalty.
For your information – just in case – here are guidelines about hardship withdrawals from 401(k) plans. 403(b) plans and 457(b) plans typically follow similar guidelines.
A 401(k) plan sponsor may provide for hardship distributions, but it is not obligated to. If your plan sponsor does allow them, the IRS defines a hardship as “an immediate and heavy financial need of the employee,” which also includes the need of the employee’s spouse or dependent. Specifically, the IRS lays out six areas where a hardship may be justified:
- Medical care
- Purchase of a principal residence
- Educational payments
- Foreclosure or eviction from a principal residence
- Funeral and burial expenses
- Repairs to a principal residence because of a casualty loss
Keep in mind that a hardship withdrawal is reserved for extreme financial difficulty. The IRS says, “A distribution is not considered necessary to satisfy an immediate and heavy financial need of an employee if the employee has other resources available to meet the need, including assets of the employee’s spouse and minor children.”
If you qualify for a 401(k) hardship withdrawal, your plan sponsor will explain what evidence they need of your financial burden. They generally will not pry into your financial situation. But you will have to certify that the need is “immediate and heavy,” that you have obtained all other distribution or loan options available under the plan, and that you understand you may not be eligible to make elective contributions or receive matching contributions for six months. It is also important to keep records evidencing the need.
What about IRAs? There are no “hardship withdrawals” per se. However, there are some exceptions to the 10% early withdrawal penalty. The most common exceptions are as follows:
- After death of the IRA owner
- Total and permanent disability of the IRA owner
- Qualified higher education expenses
- Qualified first-time homebuyers, up to $10,000
- Medical expenses greater than 10% of adjusted gross income
As stated already, we hope this is wasted information because we hope you never experience a hardship. Having said that and in our opinion, it is good to be armed with knowledge in advance in case challenging financial times pop up.