5 Things to Consider Before Taking a 401k Hardship Withdrawal

(FYI – try my corporate site’s education page on hardship withdrawals here for more information and If you would like to consider professional advice on this topic, go to my corporate site, review how I work with prospective clients to see if there’s a fit and contact me if it sounds good. Learn more by clicking HERE.)

Many people are facing financial hardship these days. Whether it’s because they lost a job, suffered an accident, or failed to build a cash reserve fund for emergencies, many folks are digging into their 401(k) plans and taking “hardship withdrawals.”

I know this is quite a hot topic because an article I wrote some time back regarding hardship withdrawals (401k Loans Down but Hardship Withdrawals Up – 9/2/08) still gets quite a number of views each week from web searches. With this data, I will assume that MANY people are considering this very drastic move! Before you do that though consider these points:

1. Remember this MAJOR POINT, except for item “2” noted below, you will almost always pay a 10% penalty on hardship withdrawals from 401(k)’s (if you’re over age 59 1/2, then it’s not a “hardship withdrawal”) and I’ll leave room for special IRS rulings) in addition to income taxes. Also remember that if you withdraw money from an IRA at an age below 59 1/2, unless there are special circumstances (and there are a few of them), you will also pay a 10% penalty tax + income taxes (cost basis may be a factor here too). I bring this point up because some people mistakenly believe that because it’s a “hardship,” they won’t pay the penalty = wrong!

2. Over 55 Separation Withdrawals Allowed – If you are over 55, and separated from your employer after attaining age 55, you can withdraw from your 401(k) without penalty. Warning! If you roll this money to an IRA, then you lose this privilege

3. If you are still working at the company that sponsors your 401(k) and you have a 401(k) and you are under the age of 59 1/2, then you might not be able to take a hardship withdrawal even if you need the money (hardship withdrawals are at the company’s discretion). Solutions? If you have an old 401(k), you may be able to withdraw those funds. If that former company also prohibits hardship withdrawals, then you can roll those funds to an IRA and take your early withdrawal from that – remember there will still be a penalty of 10% on that withdrawal in addition to the income tax owed! Also, if you have an IRA currently, you can likely cash that out with penalties and taxes, depending on the reason (IRA’s have some exceptions to the 10% penalty including first time home purchase and qualified education expenses).

4. Consider a 401(k) loan – though the amount you can withdraw is limited, you do pay back interest and principal to yourself and if you are in dire straits, you could avoid disrupting cash flow by replacing the loan repayment for the 401(K) contributions you were doing. Of course this means saving less but we wouldn’t be talking about hardship withdrawals in the first place unless the situation was rather serious don’t you agree? Ask your HR rep about loan provisions before jumping into it.

5. This is a bit more general – but, if you have an investment that you’d like to make, but it falls outside the scope of the normal investment landscape, consider a self-directed IRA. I have encountered some people that want to buy a piece of real estate, or invest in a private stock offering or hedge fund but all of their cash is tied up in a 401(k) or IRA. By moving from a traditional IRA to a Self-Directed IRA, you might be able to buy that “odd” investment inside the IRA! And avoid the penalties and taxes of cashing out.

Of course, with any and all of these ideas, consult a professional: ideally a CPA, financial planner, and/or tax attorney before making ANY move. If you are facing financial difficulties, perhaps you need to talk to someone. If so, and if you want to find a low-pressure way to get some feedback on your situation, Go HERE to my company website to learn about my “client process” and how I might help. Please note that, if you are in a particularly difficult financial situation, I do offer pro bono services.

For more information on retirement planning, see “Retirees Should Be More Focused on Outcomes not Probabilities” and “The Debt Crisis Will Strike Us Suddenly and How You Can Protect Yourself” or enter retirement topics such as “IRA,” “401k,” or “Pension” in the search box to the right.

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If you want more in-depth financial education and information on hardship withdrawals (and other financial information, try my corporate site’s Financial Research Pages by clicking HERE.