Difference Between Hardship Withdrawal & Rollover Withdrawal

Understanding your 401(k) withdrawal options can be a key part of planning for your retirement.

Understanding your 401(k) withdrawal options can be a key part of planning for your retirement.

According to the Investment Company Institute, more than 51 million Americans actively participated in a 401(k) program in 2011. With company pensions dwindling in recent years, a 401(k) account is sometimes an employee’s sole source of retirement savings. Because the Internal Revenue Service allows 401(k) contributions on a pre-tax basis, it can be very difficult -- and often costly -- to draw funds from your 401(k). Withdrawals are allowed, however, in specific cases of financial hardship or when the funds are rolled over into another retirement account.

401(k) Withdrawal Requirements

The IRS has detailed restrictions on the withdrawal of funds from your 401(k). Usually, you will only be able to tap your 401(k) directly if you are experiencing an approved financial hardship and have no other financial resources. This restriction is in effect until you are 59 ½ -- or older than 55 if you retired in the year you turned 55. You might not be able to withdraw your funds without penalty if you are older than 59 ½ but still working. You’ll need to check with your 401(k) administrator for the exact details on your withdrawal limitations.

Hardship Withdrawals

Before age 59 ½, you will be able to siphon from your 401(k), but it will cost you. The IRS allows you to make hardship withdrawals for qualifying financial burdens. Some of these include extensive medical bills, educational debt, funeral expenses or a down payment on a home. To withdraw from your 401(k) to cover any qualified financial hardship, you’ll be required to pay the IRS a 10 percent penalty for early withdrawal, plus all applicable state and local income taxes. You’ll need to check with your employer’s human resources department or 401(k) administrator to determine whether hardship withdrawals are allowed and, if so, whether your situation qualifies.

IRA Rollover Withdrawals

It’s possible to withdraw funds from your 401(k) and transfer them into another retirement account. This transaction is called a rollover and can be completed without paying taxes or penalties if you follow your administrator’s requirements. Typically, you can only roll over your 401(k) funds into an independent retirement account, or IRA, after terminating your employment with the company that sponsored your 401(k) plan. IRA accounts come in many types, and many factors will determine your eligibility for each. Some of these factors include your current employment status, age and income. To avoid paying taxes and penalties on the withdrawn 401(k) funds, you’ll need to make sure the money is deposited into an IRA within 60 days. A rollover withdrawal can be a good idea, since IRA accounts typically give you more investment flexibility. Since you administer the account, you can decide where the funds are invested. Your 401(k) investments, on the other hand, are limited to those provided by your account administrator.

New Employer 401(k) Rollover Withdrawals

If you’re changing jobs, it’s possible to withdraw the funds from the 401(k) account sponsored by your previous employer and deposit them into the account sponsored by your new employer. This type of rollover withdrawal is sometimes only permitted if you have a new job offer before terminating your current employment. Your new employer will also need to permit 401(k) rollovers, so check with the company’s human resources department to find out if you’re eligible. If you are able to roll over your 401(k) funds, you can avoid paying income taxes and IRS penalties on the withdrawal.

About the Author

Kristen Radford Price began writing in 2005 for her campus newspaper. She has served as a feature writer for the life-and-style section of the "Daily Herald," a contributor to "Utah Valley Weekly," an editor for a small publishing house and now as director of communications for an Internet company. Radford has a Bachelor of Arts in journalism from Brigham Young University.

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