Many 401(k) plans allow employees to make a hardship withdrawal because of immediate and heavy financial needs. Generally, hardship withdrawal and distribution are limited to the amount of the employee’s contribution and do not include any income earned on the deferred amounts. Hardship distributions are different than eligible rollover distributions.But we need to develop a better understand of 401(k) plans before we can explore the Hardship Withdrawal rules.
401(k) plans were created as Retirement Savings Plans to allow for tax-qualified contributions by an employee along with an additional contributions by their employers. These contributions would be on pre-tax basis offering great investments that could grow on a pre-tax bases. These deferred wages that the employee does not receive would be subject to income tax withholding at the time of the deferrals and they do won’t appear on your Form 1040 as ordinary taxable W-2 income.
However, they are included as wages subject to Social Security, Medicare, and federal unemployment taxes.
Many 401(k) plans allow employees to make a hardship withdrawal because of immediate and heavy financial needs. Generally, hardship distributions from a 401(k) plan are limited to the amount of the employee’s elective deferrals only, and do not include any income earned on the deferred amounts. Hardship distributions are not treated as eligible rollover distributions.
A hardship withdrawal is not like a plan loan. The withdrawal may be difficult to get, and costly if you receive it. Remember, your 401(k) is meant to provide retirement income. It should be a last-resort source of cash for expenses before then. IRS rules allow plan withdrawals in a limited number of hardship situations. To further discourage early withdrawals, in some cases the IRS imposes a hefty financial penalty.
Two types of hardship withdrawals are permitted from 401(k) plans. One is called a financial hardship withdrawal. It is subject to applicable income taxes and a 10% early withdrawal penalty if you are younger than 59½. The other is a penalty-free withdrawal made under Section 72(t) of the Internal Revenue Code. With this, you pay applicable income taxes but not an early withdrawal penalty.
Financial hardship withdrawals are allowed for the following reasons:
- Cover Un-reimubred medical expesen for you and your qualified dependents
- Pay College Tuition for yourself and a dependent
- Avoid Foreclosure or evition from your home
- To buy a primary residence
IRS Guidelines for Penalty Free Withdrawals allow for the following exceptions:
- You are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
- You become totally disabled.
- Your medical expenses exceed 7.5% of your adjusted gross income.
- You are responsible for court mandated payments for to alimony, divorce, child support
- You are separated from service and you have set up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution you are required to continue for five years or until you reach age 59½, whichever is longer.)
Keep in mind that each employee sponsored 401(k) plan has different requirements and guidelines and not all offer Hardship Withdrawals So, contact your plans administers before you starting spending any of the potential money you could receive from this kind of withdrawal.
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