Do I Have to Pay a Penalty on My 401(k) for Hardship Withdrawal?

Seek other financial remedies before early withdrawal from your retirement fund.

Seek other financial remedies before early withdrawal from your retirement fund.

The 10-percent penalty from the Internal Revenue Service on withdrawal amounts applies to qualified retirement plans, including hardship withdrawals from your 401(k). There are ways around the penalty, but only for people in certain situations unrelated to hardships and timing coincidence. Retirement plans were set up for your retirement security, so you would be wise to look for financial options if you want to avoid taxes and tax penalties.

Avoiding Penalties

Your 401(k) withdrawal will be included as part of your gross income, so you will be taxed on the income as well. You might escape the penalty on early withdrawals in cases where you have been terminated from employment at age 55 or older; need to make withdrawals as part of a domestic relations order, such as a divorce settlement; or receive distributions of dividends from employee stock ownership plans within a 401(k). You could take advantage of these opportunities if they occur during the time of your hardship.

Hardship Reasons

Hardship withdrawals from your 401(k) plan may include certain medical expenses, burial or funeral expenses, certain repairs to damage of your home and payments necessary to avoid eviction or foreclosure, costs for the purchase of a residence and tuition or educational expenses. However, the plan must specify these particular expenses. Retirement plans allow hardship distributions, but company 401(k) plans may differ on allowable distributions. A plan may only cover hardship distributions for medical issues or funeral costs, for example, but not for other expenses, according to the Internal Revenue Service.

Immediate Needs

The need for the withdrawal must be immediate and considered a heavy burden on your financial situation. The employee must not have other resources, such as property or assets that can be used for emergency finances. You need to have exhausted all other remedies, including available distributions from financial accounts, insurance compensation and loans under the plan from your employer. The amount you withdrawal cannot be more than the amount of your total contributions, including any Roth IRA contributions, at the time of your withdrawal. This does not include non-elective or matching contributions. You will also be forbidden to make contributions to the plan or other plans under your employer for six months after receiving your hardship distribution.

Consider Options

Consider all your options before taking early withdrawals from your 401(k) plan if you want to avoid paying a penalty and additional taxes. Your company may allow loans from the plan under IRS regulations for up to half of the balance. You usually have five years to repay the loan, which is not taxed, but you will have to pay interest and you must repay the loan immediately if you leave the company. The loan will otherwise count as income, taxed and penalized by the IRS. Take the minimum loan amount you can to get through your predicament, so you can get back to contributing and financial security sooner. If you need emergency money and can hold out for a while, stop making contributions to your plan to use the money for your financial needs during your hardship. Start refunding the plan when you can.


About the Author

Jerry Shaw writes for Spice Marketing and LinkBlaze Marketing. His articles have appeared in Gannett and American Media Inc. publications. He is the author of "The Complete Guide to Trust and Estate Management" from Atlantic Publishing.

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