Taking a hardship withdrawal from one of your retirement accounts will not ding your credit. You own the money in your accounts, so taking a withdrawal is akin to taking money out of your savings account, although there may be taxes and penalties involved. Borrowing from your retirement accounts will not harm your credit, either. However, there are long-term consequences to taking early withdrawals from your retirement accounts.
The Internal Revenue Service permits hardship withdrawals from retirement plans, but it doesn't require employers to provide them. However, many plans that allow elective deferrals, such as 401(k) plans, do allow hardship withdrawals. The qualifications for a hardship withdrawal are vaguely worded, only requiring an "immediate and heavy financial need." Generally, withdrawals are permitted for medical expenses, the first-time purchase of a home, educational fees, funeral expenses, home-repair expenses and money to prevent eviction or foreclosure.
Taxes and Penalties
Even hardship withdrawals are subject to ordinary income tax, like any other distribution from a retirement plan. Also, you may still have to pay the 10 percent early distribution penalty if you are under age 59 1/2. According to Registered Rep magazine, the only exceptions to the penalty for retirement plans are total and permanent disability, loss of job after age 55, unreimbursed medical bills greater than 7.5 percent of your adjusted gross income, court-ordered family support payments, and substantially equal periodic payments -- also known as 72(t) withdrawals. For individual retirement accounts, you can also avoid the penalty if you use the money for a first-time home purchase, certain health insurance premiums, federal tax payments or higher-education expenses, according to Bankrate.com.
You can avoid taxes and penalties if you take a loan against your retirement account instead of a hardship distribution. While you have to pay interest on your loan, you pay it back to yourself. Loans have to be paid back within five years and cannot generally exceed 50 percent of your account balance. You cannot take a loan against an IRA, but you can against most other types of retirement plans, including 401(k) plans. As with hardship withdrawals, loans are permitted by IRS rules but are subject to approval by your employer.
Your retirement accounts should be your last option when it comes to satisfying short-term financial needs. The money you take out cannot be replaced and will not be available for you in retirement. Because of the compounding effect of time, the money you take out today could be worth much more in the future than it is today if you were to leave it in your tax-deferred retirement account.
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