What to Know About a 401(k) Hardship Withdrawal

Hit with a big financial emergency and need some quick cash to cover it? You might look to your 401(k) savings, but beware of the possible pitfalls of tapping into retirement savings.

Written by Medora Lee / July 15, 2022

Quick Bites

  • You can tap your 401(k) in times of hardship, like when you need quick money to cover a major financial emergency.
  • Depending on your situation, you can consider taking a hardship withdrawal or a loan. Each has pros and cons, which are explored here.
  • Try to find alternatives before turning to your 401(k).

If you suddenly have a heavy financial need, you can withdraw money from your 401(k) retirement savings plan. However, you can only take out the amount of money that’s necessary to cover your need, and the withdrawal is subject to income tax. You may also be subject to an additional 10% tax for early distributions.[1]

Inside this article

  1. What's a 401(k)?
  2. 401(k) hardship withdrawals
  3. Bipartisan budget act changes
  4. Reasons for a withdrawal
  5. What’s your employer’s role?
  6. Paying medical bills
  7. Disability
  8. Penalties
  9. What about SEPPs?
  10. Calculating withdrawal
  11. Separation of service
  12. How about a loan?
  13. Do I have to pay it back?
  14. Do I need proof?

What's a 401(k)?

A 401(k) plan is an employee-sponsored retirement plan that workers can contribute to via payroll deductions. If you’re lucky, some employers also offer a match to your contribution up to a certain amount each year.

There’s no minimum to contribute, but the IRS caps the maximum each year. For 2022, the annual contribution limit for workers 50 and younger is $20,500. Those 50 and older are allowed to add a “catch-up” contribution of $6,500.[2]

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How 401(k) hardship withdrawals work

These withdrawals are meant to be a last resort if you’ve exhausted all other avenues of getting money to pay for your financial hardship. If you’ve determined that there’s no other way to finance your hardship, you’ll have to contact your plan sponsor to find out what the hardship withdrawal requirements are and go through the paperwork.

According to the IRS, an employee is automatically considered to have an immediate and heavy financial need if the distribution is for any of these:[3]

  • Medical care expenses

  • Costs directly related to the purchase of your home (excluding mortgage payments)

  • Tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education

  • Threat of eviction from your home or mortgage foreclosure

  • Funeral expenses

  • Certain expenses to repair damage to your home

Bipartisan budget act changes

In 2019, new rules around hardship withdrawals were enacted that benefited workers.

The changes meant that employees could not only withdraw their own money but also take the earnings on the money and company contributions as part of a hardship withdrawal. They also no longer had to consider first taking a loan from their 401(k) before requesting a hardship withdrawal.

Additionally, they were no longer suspended for six months after taking a hardship withdrawal from contributing to their 401(k).[4]

Reasons for a 401(k) Hardship Withdrawal

Some of the reasons people may take a 401(k) hardship withdrawal include:

  • Out-of-pocket medical expenses

  • Down payment or repairs on a primary home

  • College tuition and related educational expenses

  • Threat of mortgage foreclosure or eviction

  • Burial and funeral expenses

What’s your employer’s role?

Your plan has a sponsor, which can be your employer or a third party hired by your employer. All plans are different so whether your request will be approved will depend on the guidelines of your plan. Not all plans even offer hardship distributions because they’re not required by law.

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The plan sponsor will be able to advise you, review your request and let you know what documentation and paperwork you will need to obtain a hardship withdrawal.

Paying medical bills

If you have an unreimbursed, qualified medical bill, you may take a hardship distribution. The distribution will be subject to income tax but you can avoid the 10% early withdrawal penalty if your medical bills exceed 7.5% of your adjusted gross income.[5]

Disability

You can take a hardship distribution and also get the 10% early withdrawal penalty waived if your hardship stems from your total and permanent disability.

Penalties

Hardship withdrawals are subject to a 10% early distribution penalty unless at least one of the following criteria is met:[5]

  • You’re totally and permanently disabled

  • Medical bills exceed 7.5% of your adjusted gross income

  • The money is going towards a court order to pay funds to a spouse, child or dependent

  • You’re permanently laid off, terminated, quit or retired early in the same year you turn 55

  • You’re permanently laid off, terminated, quit or retired and will receive payments for the rest of your (or your designated beneficiaries') life or life expectancy for at least 5 years or until you reach age 59 ½, whichever is longer (see SEPP below)

What about SEPPs?

Substantially equal periodic payments, or SEPPs, allow you to withdraw from your retirement accounts before age 59 ½ without incurring the 10% early distribution penalty. These aren’t subject to hardship distribution requirements so they are open to anyone who’s willing to meet the withdrawal terms and has retirement accounts.[6]

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If the money is being withdrawn from an employer-sponsored plan, you must stop working for the employer maintaining the plan before the payments begin to get the exception.

The “substantial amount” you withdraw is based on life expectancy. There are three ways the IRS says you can calculate that amount:

  • The required minimum distribution method

  • The fixed amortization method

  • The fixed annuitization method.

Each method produces a different annual withdrawal amount.

To take advantage of this, you'll need to withdraw money from your qualified retirement accounts at least once per year, and must continue the withdrawals for at least five years, or until you reach age 59 1/2, whichever is longer.

That means if you’re going to take SEPP at the age of 50, you will have to take annual withdrawals until you reach 59 ½. If you’re 57, you’ll have to take a distribution each year for five years.

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If you terminate or modify these payments before the end of the required time, you’ll have to pay the 10% penalty, applied retroactively. However, there is a one-time change allowed from either the amortization method or the annuitization method to the required minimum distribution method.

Calculating withdrawal

There are three methods to calculate the amount you’ll have to withdraw under SEPP. They are:

  • The required minimum distribution method

  • The fixed amortization method

  • The fixed annuitization method.

All of them are based on life expectancy.[6]

The required minimum distribution method uses your account balance and life expectancy based on your age and using an IRS table. It is recalculated each year.

The fixed amortization method uses your account balance amortized over a specified number of years equal to life expectancy (based on an IRS table) and an interest rate of not more than 120% of the federal mid-term rate. The dollar amount stays the same every year.

The fixed annuitization method consists of an account balance, an annuity factor and an annual payment. The annuity factor is calculated based on the mortality table provided by the IRS and an interest rate of not more than 120% of the federal mid-term rate. Once calculated, the same dollar amount is distributed each year.

Separation of service

If you’re withdrawing a substantial amount from an employer-sponsored plan, you must not be working for that employer by the time the first payment begins to avoid the 10% early withdrawal penalty.

How about a loan?

You can take a loan from your 401(k) account and pay it back with interest to your account. You have to pay back the loan within 5 years, and at least quarterly payments must be made in mostly equal payments that include principal and interest. But if you’re using the money to buy a home where you’ll be living full time, some plans allow you to borrow for 25 years.

Loans are capped at 50% of your savings, up to a maximum of $50,000, within a 12-month period, and you may need consent from your spouse or partner to take a loan.

You don't have to pay taxes and penalties on loans. But if you leave your employer, you may have to repay the entire loan quickly before you go.

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If you default on the loan, it won’t affect your credit score but you'll owe both taxes and a 10% penalty if you're under 59½. That could negate the tax advantage you had on that money.

When you pay yourself back, you also will use after-tax dollars. That means you may be taxed again on that money when you withdraw it in your old age.

Do I have to pay back my hardship withdrawal?

No, you don’t have to pay back a hardship distribution. However, you do have to pay income tax on the amount you take out and possibly, a 10% early withdrawal penalty if you’re less than 59 ½ years old, unless you qualify for an exemption.

Do I need proof for a hardship withdrawal?

Your plan will specify what information must be provided to the employer to demonstrate a hardship, but generally you won’t have to have a probe into your financial status.

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The employer sometimes can rely on the employee's account of immediate and heavy financial need. However, the employer can’t rely on the employee’s story if it knows the employee’s financial burden can be met by reimbursement or insurance, selling assets, halting contributions to the plan or loans. You may need to submit documentation such as insurance bills, escrow paperwork, funeral expenses and bank statements.[8]

Article Sources
  1. “Retirement Plans FAQs regarding Hardship Distributions.” IRS. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions
  2. “401(k) Basics: When It Was Invented and How It Works.” Northwestern Mutual. March 30, 2018. https://www.northwesternmutual.com/life-and-money/your-401k-when-it-was-invented-and-why/
  3. “Retirement Topics - Hardship Distributions.” IRS. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions
  4. “Budget Law Eases 401(k) Hardship Withdrawals.” SHRM. https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/bipartisan-budget-act-eases-401k-hardship-withdrawals.aspx
  5. “401(k) Hardship Withdrawals—Understand the Tax Bite and Long-Term Consequences.” FINRA. https://www.finra.org/investors/401k-hardship-withdrawals
  6. “Substantially Equal Periodic Payments.” IRS. https://www.irs.gov/retirement-plans/substantially-equal-periodic-payments#6
  7. “Thinking of taking money out of a 401(k)?” Fidelity. https://www.fidelity.com/viewpoints/financial-basics/taking-money-from-401k
  8. “401(k) Loans, Hardship Withdrawals and Other Important Considerations.” FINRA. https://www.finra.org/investors/learn-to-invest/types-investments/retirement/401k-investing/401k-loans-hardship-withdrawals-and-other-important-considerations

About the Author

Medora Lee

Medora Lee

Medora has more than 25 years of experience reporting, writing and editing mostly as a finance and economics journalist around the globe. She has covered every aspect of finance and economics, including the fall of Barings Bank in 1995 and Europe's transition to Economic and Monetary Union and the birth of the euro. She has worked at such international stalwarts as Reuters and Forbes.com as well as startups that grew up like theStreet.com.

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