Despite offering substantial tax breaks while saving for your retirement, especially if your employer offers matching funds, 401(k) plans are extremely strict when it comes to early withdrawals. If you want to get your hands on the money before you turn age 59 1/2, you have limited options, most of which are subject to an early withdrawal penalty and any tax due on the distribution.
The Internal Revenue Service definition of "hardship" probably doesn't resemble yours. Permissible expenses include medical costs, funeral expenses, college tuition or a down payment on a home. You must show you have no other available resources before the plan will make a distribution. You can only withdraw up to the amount contributed, not employer matching funds, and you won't be able to contribute for six months after the distribution. Hardship withdrawals are subject to regular income tax plus a 10 percent early withdrawal penalty.
If you meet certain conditions, you qualify for a penalty waiver. These include taking a 401(k) distribution when you leave a job after age 55 -- or age 50 for public safety employees -- or paying medical expenses of more than 7.5 percent of your adjusted gross income. Other eligible situations include the death or divorce of the plan participant, the pass through of dividends from employee stock option plans, a qualified reservist distribution, an IRS levy of the plan and the return of excess contributions. You still have to pay regular income tax on the distribution.
A simple and almost painless way to avoid the restrictions and penalty is to take a loan from your 401(k) plan. The IRS doesn't get involved here, so it's tax-free and penalty-free. You'll have to pay the money back with interest, but you're free to spend it however you like. If you don't pay it back on time, the unpaid portion is taxed and penalized as a normal early distribution. You can borrow up to 50 percent of your vested account balance, with a maximum of $50,000, and you must pay it back within five years.
If you are changing jobs or are in another situation where you can roll over your 401(k) funds to an individual retirement account, this allows more options for penalty-free waivers. As a last resort, if you need the funds for a purpose that doesn't qualify for the waiver, consider a rollover distribution. With this situation, you deposit only part of the proceeds into an IRA and hold back what you require to cover your immediate financial needs.
If you take an early withdrawal, you can't put the money back into the plan, so you'll end up with a gap in your retirement savings. Taking a loan against the funds at least allows you to maintain the principal, although you'll lose earnings on the money until it's repaid. If you're in a temporary hardship situation, consider whether a loan might be the better option than taking a chunk out of your retirement and ponying up the penalty on top.
Naomi Smith has been writing full-time since 2009, following a career in finance. Her fiction has been published by Loose Id and Dreamspinner Press, among others. She holds a Master of Science in financial economics from the London School of Economics and a Bachelor of Arts in political economy from the University of California, Berkeley.