Man holding money | iStock.com/Alen-D
One day you’re enjoying your job and loving life. Things are going
well and you have no complaints. Then, seemingly overnight, you’re
living your worst nightmare. You’ve been laid off, your
unemployment benefits will end soon, and you’ve blown through your
emergency savings fund.
If you’re in a tight spot and you can’t figure out how to make ends
meet, you might be considering requesting a hardship withdrawal from
your retirement account. This is often the last resort for those who
have cleaned out their savings and run out of other sources of money.
Ed Snyder, a certified
financial planner and co-founder of
Oaktree Financial Advisors,
says that while a hardship withdrawal can be a lifesaver in a time of
need, there are still some catches to watch out for. “A 401(k) hardship
withdrawal helps bail you out of a really tight spot when you have no
other options. However, depending on your income and the amount of the
withdrawal, the distribution could put you into a higher tax bracket,”
warns Snyder in an interview with The Cheat Sheet.
Here’s what you should know before you withdraw money from your retirement account.
1. Your request could be declined
401 (k) plan | iStock.com
Not all retirement plans offer the option for hardship withdrawals
because it’s not a required feature. So make sure to check first and see
if you are able to receive a distribution. Also know that a
determination will be made regarding whether you really have a
significant need. If it is determined that you or your spouse have
assets available, you will most likely not be granted a hardship
distribution. The IRS uses a vacation home as an example of an available
asset that could be liquidated to help cover an unexpected financial
emergency.
2. Know what qualifies as hardship
Are you rich or poor? | iStock.com
If your retirement plan does offer the option to take a hardship
withdrawal, it will outline the specific requirements to qualify. One of
the requirements is that you must have what is referred to by the IRS
as an “immediate and heavy financial need.” The IRS automatically
considers an employee to be in immediate and heavy financial need if the
distribution request is for expenses such as funeral costs or
significant medical costs. You’ll also automatically qualify if you need
the money to prevent an eviction from or
foreclosure
on your primary residence. These are known as safe harbor
distributions. For further information on what qualifies as a safe
harbor distribution, see the IRS publication titled
Retirement Topics—Safe Harbor Distributions.
When it comes to 401(k) hardship withdrawals, your family won’t be
left out in the cold. Requests can also be made to meet the financial
need of a spouse or dependent. In addition, a request can also be made
for expenses to assist a non-spouse or non-dependent beneficiary, thanks
to the
Pension
3. You’ll have to wait to make future contributions
Hand holding out money | George Marks/Retrofile/Getty Images
If you’re suddenly in the position to contribute to your plan again,
tough luck. Know that if you want to make contributions to the plan,
you’ll generally be required to wait at least six months after you
receive a hardship distribution. That means you lose the value of having
your money invested in the markets.
4. You’ll owe taxes–and most likely penalties, too
IRS | Win McNamee/Getty Images
Taxes and penalties are in your future. Unlike a 401(k) loan, a
hardship distribution does not have to be repaid. However, you will owe
taxes on the distribution because it’s considered income. In addition,
if you are less than age 59 ½, you’ll also owe a 10% early withdrawal
fee.
Jeff Rose, certified financial planner and founder of personal finance blog
Good Financial Cents,
says a 401(k) hardship withdrawal should be taken with caution.
Depending on the situation, the consequences could outweigh the
benefits. He recommends looking at other options first, such as taking
out a personal loan. “Using a 401(k) hardship withdrawal should only be
done as a last resort. Look for all other options for accessing money
before tapping into your 401(k) retirement savings,”
Rose says
on his blog. “A 401(k) hardship withdrawal reduces the amount of your
retirement account permanently since it’s never repaid, you’ll miss out
on compounding interest and earnings, and most likely pay both income
taxes and penalties on the amount withdrawn, making it an expensive
option for gaining access to your money.”
Culled from Money & Career Cheat Sheet
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