401K Hardship Withdrawal

401K Hardship Withdrawal

NEW YORK (CNNMoney) -- A large number of Americans are borrowing against their 401(k)s and having a hard time paying the loans back. Defaults on 401(k) loans are draining retirement savings by as much as $ 37 billion a year, according to a study ... Loan defaults drain billion from 401(k)s each year

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A 401k Hardship Withdrawal Sometimes Creates Hardships

Attorneys say, “When in doubt, consult the statutes.”  Of course, that’s lawyer-speak for “read the book.”  Here’s what the book says about 401k hardship withdrawal:

 

For a distribution from a 401k to be on account of hardship, 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.

 

Some of the expressions in the statute carry extra weight in real life. 

 

“Immediate and heavy,” for example, usually means you will have to prove your need to your employer.  With the understanding that he will protect the confidentiality of all you disclose, your employer is entitled to documentary evidence of your need to take a 401k hardship withdrawal.  Specifically, you will have to prove the need’s severity, your lack of other resources for meeting the need, and you either have taken loans against your 401k or the plan’s loan limits don’t cover your need. 

 

Similarly, “the amount must be necessary to satisfy the financial need.”  Specifying the amount of your 401k hardship withdrawal, you must match your request to the total of the bills you cannot pay.  Normally, employers show greatest concern when your request for a 401k hardship withdrawal exceeds the total of your obligations; ordinary common sense dictates that your employer has every right to know the reason for requesting the excess.  But shortfalls matter, too.  If you suffer a “heavy” need, why haven’t you petitioned for a 401k hardship withdrawal to the full extent of your obligations?

 

Your employer also will certify you meet the plan’s conditions for a 401k hardship withdrawal; you cannot request your 401k hardship withdrawal for any reason at all.  You legitimately may request a 401k hardship withdrawal if you intend to use the money for: (1) purchase of your first home, or (2) the cost of higher education for a family member, or (3) to prevent eviction from or foreclosure on your home, or (4) tax deductible medical expenses you cannot pay by any other means.

 

A 401k hardship withdrawal is not the extreme form of a loan; you cannot repay a 401k hardship withdrawal.  You forfeit both the interest and dividends on those funds, and you forfeit the lifetime tax advantage those funds would offer.  You will pay the standard 10% penalty on your 401k hardship withdrawal, and the money will be subject to regular income taxes.  Depending on your tax bracket and other circumstances a $ 10,000 401k hardship withdrawal may net you only about $ 7000.

 

As with all early distributions from your retirement account, a 401k hardship withdrawal represents a last resortâ€"the option you begin to consider only after you have exhausted all your other remedies, including the ones you had told yourself, “I never would…”  If you genuinely have no other choice, then you should request a 401k hardship withdrawal, keeping in mind that the tools for relieving your hardship will bring hardships of their own.

Suggest 401K Hardship Withdrawal Issues

Question by Kyle D: Can interest earned on a loan against a 401K for home improvements be counted as mortgage interest? Best answer for Can interest earned on a loan against a 401K for home improvements be counted as mortgage interest?:

Answer by digdowndeepnseattle
No. Nor can interest on a loan taken specifically to BUY a home be counted as mortgage interest. Used to be able to do it but now you can't.

Answer by oakhill
The home mortgage interest deduction is any interest you pay on a loan secured by your home. Since you borrowed using your 401K as the security, it is not deductible. For more details, see the attached link to the IRS pub. on Mortgage Interest Deductions.

[loans against 401k home]