In times of crisis or emergency, many plan sponsors desire to help employees through financial challenges. Some plan participants may consider pulling money out of their retirement plans by taking out a 401(k) hardship withdrawal. In this blog, we explain what plan sponsors should know about 401(k) hardship withdrawals and how they can help participants through the distribution process.
What is a 401(k) Hardship Withdrawal?
401(k) hardship withdrawals are a type of in-service dsitribution that a plan sponsor may write into their plan. If allowed in the plan a participant, if they qualify, may take a hardship from the plan to meet specific financial needs defined by the IRS.
That said, these withdrawals have many rules and limitations when it comes to how they can be used.
401(k) Hardship Withdrawal Rules and Regulations
When it comes to 401(k) hardship withdrawals, the IRS has specific guidelines for how they can be used. Here is what you need to be aware of:
Approved Reasons
The IRS only permits withdrawals for “immediate and heavy” financial needs. Qualifying reasons for withdrawal include:
Health care expenses for the participant, their spouse, or a dependent
Funeral expenses for the participant’s spouse or a dependent
Purchase or repairs to a principal residence
Payments to prevent eviction
Tuition and room and board for the participant’s, their spouse, or a dependent
Expenses resulting from a declared disaster
Eligibility
It is not a requirement for plan sponsors to permit 401(k) hardship withdrawals, so participants should contact their plan sponsor to determine if they are eligible. On the other side, plan sponsors should clearly communicate if hardship withdrawals are accessible in your organization’s plan.
Expenses also cannot be coverable by any other resources available to the participant.
Withdrawal Limits
401(k) hardship withdrawals limit how much money a participant can pull from their retirement. They may only withdraw the amount needed to cover the emergency, plus any additional taxes or fees. Any withdrawal amount is subject to a 10% penalty on the amount withdrawn if the participant has not yet reached 59 ½ years of age.
Having a clear understanding of 401(k) hardship withdrawals is beneficial to both the plan sponsor and participant.
Outcomes for Withdrawing
Though a 401(k) hardship withdrawal may help participants in the present moment, there are long-term impacts to be aware of. Along with causing a major setback to retirement savings and plans, here are some factors that need to be considered:
Less in 401(k), less interest gained: Withdrawing money means less money in the participants retirement fund, which also sees less interest accumulated over time.
Income tax on previously untaxed money: Participants would owe income taxes on any distributions from their 401(k) hardship withdrawal. Plus, the IRS may charge a 10% early distribution penalty on the amount taken out if they are below the age of 59 ½.
Working Together: How Participants Should Apply for a Hardship Withdrawal
If a participant is looking to request a 401(k) hardship withdrawal, the first step is to meet with their employer or plan sponsor to discuss what requirements must be met to qualify for a hardship and what documents participants must provide as proof of hardship:
Statement regarding the emergency and related expenses
Receipts or invoices
Title insurance documents
Certification that the information is accurate
Consult with RPCSI
Financial stress is never easy, but plan sponsors can be supportive of plan participants as they navigate their difficulties. RPCSI is here to help plan sponsors navigate their retirement plans, including 401(k) hardship withdrawals, with confidence. With our wealth of experience and information, our team can support you and the people of your organization through all of life’s difficulties.
Contact us to schedule a consultation and learn more about how we can help you.
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