What is a 401k Hardship Withdrawal?

The IRS permits (but does not require) 401k plans to provide for hardship distributions. Nearly all 401k plans do, in fact, offer hardship withdrawals.

For a distribution from a 401(k) plan to be a hardship distribution, it must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need. The need of the employee includes the need of the employee’s spouse or dependent. The need of the employee also may include the need of the employee’s non-spouse, non-dependent beneficiary.

Whether a need is immediate and heavy depends on the facts and circumstances. There are six “safe harbor” expense categories that the IRS automatically deems to be immediate and heavy:

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

The majority of hardship withdrawals do, in fact, fall into these six safe harbor categories:

Hardship Withdrawal Reason
Percent of Hardship Withdrawals
Eviction from Home
Home Purchase
Damage to Home

Other purposes may also qualify for a hardship withdrawal, but it is important that the use truly satisfy “an immediate and heavy financial need”. According to the IRS:

A distribution is not considered necessary to satisfy an immediate and heavy financial need of an employee if the employee has other resources available to meet the need, including assets of the employee’s spouse and minor children. Whether other resources are available is determined based on facts and circumstances.

A distribution is deemed necessary to satisfy an immediate and heavy financial need of an employee if: (1) the employee has obtained all other currently available distributions and loans under the plan and all other plans maintained by the employer; and (2) the employee is prohibited, under the terms of the plan or an otherwise legally enforceable agreement, from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least 6 months after receipt of the hardship distribution.

A hardship distribution may not exceed the amount of the employee’s need. However, the amount required to satisfy the financial need may include amounts necessary to pay any taxes or penalties that may result from the distribution.

What are the consequences of taking a hardship distribution of elective contributions from a 401k plan? After an employee receives a hardship distribution of elective contributions from his or her 401k plan, generally the employee will be prohibited from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for 6 months.
Are hardship distributions taxable? Hardship distributions are generally includible in gross income. In addition, they may be subject to an early distribution penalty. Unlike loans, hardship distributions are not repaid to the plan. Thus, a hardship distribution permanently reduces the employee’s account balance under the plan.
Studies show that… Women are more likely to take 401k withdrawals than men. Also, lower earning workers are more apt to take withdrawals.
What is the maximum amount of elective contributions that can be distributed as a hardship distribution from a 401k plan? The amount of elective contributions available for a hardship distribution cannot be more than the amount of the employee’s total elective contributions as of the date of distribution less the amount of any previous distributions.

Policymakers, as well as some employers, are becoming increasingly concerned that 401k withdrawals are contributing to the long term problem of “leakage”. Leakage is the problem of 401k retirement assets being diverted to other non-retirement purposes via 401k withdrawals, 401k loans or 401 cash outs when leaving a job. It is very possible that limitations on 401k hardship withdrawals may be increased in coming years. Possibilities under discussion include:

  • limiting allowable reasons for hardship withdrawals to the 6 safe harbor reasons outlined above
  • allowing participants to “re-contribute” funds taken out via hardship withdrawal at a later date when circumstances may have improved
  • restrict amounts available for withdrawl
  • restrict the number of withdrawals participants can take within a certain period

BOTTOMLINE: 401k hardship withdrawals are an integral part of just about all 401k plans. But taking a hardship withdrawal can severely damage to long term retirement planning and funding. Avoid taking a 401k hardship withdrawal if at all possible. If you determine there is no other alternative, talk to a trusted financial advisor as well as to your employer’s 401k administrator to ensure you fully understand the 401k hardship distribution process.