What Is a Hardship Withdrawal?

The IRS defines a hardship withdrawal as an emergency withdrawal from a retirement plan for “an immediate and heavy financial need.” Individuals can withdraw cash from plans like conventional IRAs or 401ks without penalty if they fulfill specific conditions about their need and quantity.

Despite waived penalties (e.g., a 10% penalty for withdrawals before age 59½), ordinary income tax applies to withdrawals.

Knowing Hardship Withdrawals

Use hardship withdrawals cautiously and only after exhausting all other options to secure emergency money without a credit check. Harmful withdrawals expose tax-sheltered account money to income tax, increasing your tax burden for the year. More importantly, it will permanently deplete retirement money.

When your financial situation improves, hardship withdrawal monies cannot be returned to the account, unlike 401(k) loans.

Due to these drawbacks, only employ a hardship withdrawal in emergencies. The IRS and most 401(k) employers restrict when and how much the IRS and employers allow.

Retirement fund types have different withdrawal procedures and administrators.

Hardship IRA withdrawals

For IRA withdrawals made before age 59½ due to medical hardship, the IRS waives the 10% penalty. If you lack health insurance or find your medical expenditures exceed your annual coverage, you may be entitled to receive penalty-free IRA distributions to cover part of them. You can only claim the difference between these costs and 7.5% of your adjusted gross income (AGI).

Unemployed people can take advantage of penalty-free medical insurance payouts. You must have lost your job and earned federal or state unemployment compensation for 12 weeks to qualify. You must receive payments the same year or the year following receiving unemployment compensation and no later than 60 days after finding a new job. The bills must be significant—at least 10% of your AGI—and uninsured.

The IRS now allows early, penalty-free IRA withdrawals for non-hardship reasons. These include having a mental or physical impairment or needing money for further education for you, your spouse, or your children or grandkids.

Hardship 401(k) withdrawals

The employer who sponsors your 401(k) or 403(b) plan determines if and when you can obtain a hardship payout. IRS: “A retirement plan may, but is not required to, provide for hardship distributions.” 2If the plan allows such disbursements, it must define hardship, such as medical or funeral costs. Your employer may request specific information and proof of hardship.

The IRS waives the 10% penalty for withdrawals made before age 59½ if your employer allows it for a specific reason and determines the deductible amount. While these requirements are similar to IRA withdrawal waivers, notable variances exist.

Unlike an IRA, you can’t withdraw from a 401(k) to pay for medical insurance without penalty. IRA withdrawals for schooling and first-time homebuying are penalty-free under certain conditions.

The CARES Act of 2020 temporarily eases hardship withdrawal and lending requirements for people who have suffered financial hardship due to the economic crisis. See the IRS Q&A notice for information.

Hardship Withdrawal Options

Taking funds from retirement accounts before age 59½ without penalties is possible, but it involves more time and a longer-term commitment. Put your savings into a Substantially Equal Periodic Payments (SEPP) plan. You will receive yearly dividends without penalty for five years or until 59½, whichever comes later. Early withdrawals, like hardship withdrawals, waive penalties but remain subject to income tax.

The SEPP plan is unsuitable for people seeking short-term access to retirement money without penalties, as the IRS mandates its continuation for at least five years. Canceling the plan before the minimum holding time requires payment of waived penalties and interest to the IRS.

A SEPP can only access assets from an employer-sponsored qualifying plan like a 401(k) if you leave the sponsoring firm. After starting a SEPP program, you cannot withdraw or add to a retirement account. Changes to the account balance, except for SEPPs and required fees like trade and administrative charges, may modify the SEPP program and lead to IRS disqualification and the imposition of all waived penalties plus interest.

Despite these downsides, a SEPP plan is worth considering if you need cash quickly. Compared to hardship withdrawals, the programs allow you to spend your penalty-free cash more freely.

Conclusion

• If you’re under 59½ and facing financial difficulties, you may be eligible to withdraw cash from your retirement accounts without a 10% penalty.
• However, not all problems qualify, and you must pay income tax on withdrawals.
• Remember that you can’t restore the money to the account if your finances improve.
• Consider Substantially Equal Periodic Payments (SEPP) instead of hardship withdrawals.