Understand Your 401(k) Hardship Withdrawal Rules

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ParachuteWe recently purchased a home (this moved quickly!) and I complained a little about all the extra paperwork I had to fill out and all the documents I had to produce. One of the documents I had to produce was a document from my 401(k) plan administrator detailing the hardship withdrawal rules for my 401(k). The last 7-8 years of the Great Recession and people falling behind on mortgage payments has resulted in banks wanting to know if there’s some sort of backup plan. While a hardship withdrawal is hardly a great backup plan, it’s better than nothing.

As it turns out, your 401(k) isn’t required to give you the ability to make a hardship withdrawal. There are general guidelines from the IRS as to what is considered a “hardship” and how you “prove” you need the funds, but your retirement plan gets to set the specifics. The IRS has general guidelines but the basic requirement is that the distribution is made because of an “immediate and heavy financial need” and that the amount must be “necessary to satisfy the financial need.”

The IRS has listed the following as deemed immediate and heavy:

  • certain medical expenses;
  • costs relating to the purchase of a principal residence;
  • tuition and related educational fees and expenses;
  • payments necessary to prevent eviction from, or foreclosure on, a principal residence
  • burial or funeral expenses; and
  • certain expenses for the repair of damage to the employee’s principal residence.

There are also “means tests” to see if you actually need the distribution from your 401(k) or if the need can be satisfied with other funding sources. The rules can get a little complicated and your best bet is to just reach out to your 401(k) plan administrator and ask him or her what the rules are for a hardship withdrawal.

As it relates to us buying a home, the lender wanted to know if our retirement plan gave us the ability to take a withdrawal to prevent foreclosure on the house, which would be our principal residence.

The important part about this is to understand what the rules are for your plan, since your plan gets to decide what applies and what doesn’t. In the event you do need a hardship withdrawal, as many did during the Great Recession, it’s better to know what you need to prove (and what you can claim as a hardship) today, when things are calm, than tomorrow, when things may be panicked.

If things do hit the fan, it’s best to tap other sources of revenue before the retirement accounts but it’s always good to know how the parachute works even if you don’t plan on jumping out of the plane.

(Credit: Horia Varlan)

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2 Responses to “Understand Your 401(k) Hardship Withdrawal Rules”

  1. I did not realize that a 401k is not necessarily required to allow you to make a hardship withdrawal. Like you said, it is better to dip into other sources of funds first, but knowing what your options are can never be a bad thing.

  2. As both a financial advisor to individuals and to a number of 401(k) plans I agree that the hardship withdrawal should be the resource of last resort. Good luck with the new house.

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