Hardship Withdrawal

A withdrawal from a retirement account such as a 401(k) or an IRA made before the age of 59 1/2 because of financial need. In order to make a hardship withdrawal, one must demonstrate the financial need, such as the need to pay medical bills or tuition for college. Even so, a hardship withdrawal is usually subject to a penalty tax.

Hardship withdrawal.

A hardship withdrawal, also known as a hardship distribution, occurs when you take money out of your 401(k) or other qualified retirement savings plan to cover pressing financial needs.

You must qualify to withdraw by meeting the conditions your plan imposes in keeping with Internal Revenue Service (IRS) guidelines. For example, you may have to demonstrate how urgent the situation is and prove you have no other resources.

Some allowances are purchasing your primary home, covering out-of-pocket medical expenses for yourself or a dependent, and paying college tuition for yourself or a dependent.

However, if you're younger than 59 1/2, you must pay a 10% penalty plus income tax on the amount you withdraw. You also may not be permitted to contribute to the plan again for six months.

Hardship Withdrawal

A withdrawal from a section 401(k), section 403(b), or section 457 plan that is permitted when the plan participant has an immediate and heavy financial need and the withdrawal is necessary to meet that need.

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If you have a defined contribution plan, such as a 401(k), you should be eligible for a hardship withdrawal. Such withdrawals are generally permitted when expenses are deemed to be immediate and significant.

In times of need

Although best practices have been to limit loans and other causes of plan "leakage," loan and hardship withdrawal features are more common among plans overseen by an adviser; 83.1% of plans with an adviser permit loans, compared to 76.9% of plans without an adviser, and 92.4% of plans with an adviser allow hardship withdrawals, compared to 86.7% of plans without.

2016 PLANADVISER Adviser Value Survey

In spite of the perceived necessity, retirement savers almost never see a long-term improvement in their financial situation by choosing a loan or even a hardship withdrawal, Fidelity says.

One Loan Leads to Another

Hardship withdrawal provision***89.40%***86.70%***3.10%

The Influence of Plan Advisers

However, through loans or hardship withdrawal provisions, money can be taken out of the plan before participants reach retirement age.

Plugging Plan Leaks

HOW TO RESOLVE: To help stop loan and hardship problems from happening, Kalish says, sponsors need to understand that the current self-serve environment for participants who want to take a loan or hardship withdrawal should have its limits.

Avoiding The Most Common Plan Mistakes

90.2%, or hardship withdrawal provisions, 84.9% vs.

Re-Orientation

Sampson advises sponsors to consider allowing participants to take loans only to address an immediate need, though this would differ from taking an outright hardship withdrawal.

Plan Design 2015

Similar percentages apply to provisions for a hardship withdrawal. In total, 14.4% of plan participants have at least one outstanding loan.Why even offer these provisions?

Keeping Watch

"Having loan and hardship withdrawal features in a 401(k) plan is a mixed blessing-too handy for some folks, although most tend to leave it alone."

Survey Says

Both the decline in financial wellness and the increase in the percentage of employees who reported taking a retirement plan loan or hardship withdrawal were most pronounced among lower-income employees, women and members of Generation X.

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