A 401k hardship withdrawal is the early removal of some, or all, of an investor’s money, contributed to his or her 401k plan. It can provide some much-needed financial relief in difficult economic times. Penalties for early withdrawal can be costly. When all other options have been exhausted and certain criteria are met, however, it can mean access to quick cash when a person needs it the most.
To qualify for a 401k hardship withdrawal, the contributor needs to prove extreme financial need. If the money is needed to avoid eviction or foreclosure of a home, approval is usually obtained. Also, funds can often be taken out to buy a home, if the purchase is for a primary residence.
In the event that an investor needs money to pay for up to one year of college for someone in the immediate family, he or she may qualify for the 401k hardship withdrawal. Eligible college expenses for the contributor, a spouse, or children can include tuition, room and board, textbooks, and related costs. Children who are over the age of majority, and no longer dependent on their parents, can still meet the criteria.
Another reason someone may request a 401k hardship withdrawal may be if he or she needed to pay medical debts. Those that are not covered by health insurance can constitute financial need. Not all medical expenses are typically eligible, however. For example, cosmetic surgery and other procedures that are not medically necessary are not usually considered valid reasons to request the money.
There are some significant drawbacks to 401k hardship withdrawal. The money that was contributed to the fund was supposed to remain in it until the investor’s retirement. The benefit of doing this is that it is tax-deferred and earning interest. Taking money out of the fund early can result in an immediate deduction of taxes from the amount being withdrawn. Additionally, a penalty is assessed, usually 10% of the removed amount.
A person who qualifies for the 401k hardship withdrawal actually loses a significant sum of money. Depending on the amount he or she removes from the fund, thousands of dollars can be forfeited. Once the money has been withdrawn, it cannot be returned. So, the person not only loses funds through taxes and penalties, but also any interest that the original amount would have earned over time.
Not everyone who uses a 401k hardship withdrawal is subject to the 10% penalty, however. A contributor who becomes totally and permanently disabled, or whose medical bills exceed a certain sum may be exempt. Also, for cases in which a court order requires someone to use money from his or her fund to pay spousal or child support, penalty fees may be waived. Regardless of the circumstances for the 401k hardship withdrawal, however, taxes are generally assessed.