Quick Summary
A 401(k) plan may allow hardship withdrawals for an immediate and heavy financial need, limited to the amount necessary. IRS regulations list safe harbor reasons such as medical expenses, preventing eviction or foreclosure, and funeral costs. Since SECURE 2.0, plans may rely on an employee's written self-certification of the need in many cases. Hardship withdrawals are generally taxable, may carry a 10% additional tax, and cannot be repaid or rolled over.
A 401(k) is designed for retirement, but life does not always wait. Hardship withdrawals give employees a way to reach their savings during a genuine financial emergency. They are optional, they come with tax consequences, and the rules around them have changed significantly in recent years.
What a hardship withdrawal is
If the plan document allows it, a participant can withdraw money while still employed when they have an immediate and heavy financial need. The withdrawal is limited to the amount needed to cover that need, which can include amounts needed to pay the resulting taxes.
The safe harbor reasons
Most plans use the IRS safe harbor list of needs that automatically qualify as immediate and heavy:
- Medical care expenses for the employee, spouse, dependents, or primary beneficiary
- Costs directly related to buying the employee's principal residence, not including mortgage payments
- Tuition, related educational fees, and room and board for the next 12 months of postsecondary education for the employee, spouse, children, dependents, or primary beneficiary
- Payments needed to prevent eviction from, or foreclosure on, the employee's principal residence
- Funeral or burial expenses for the employee's parent, spouse, children, dependents, or primary beneficiary
- Certain expenses to repair damage to the employee's principal residence
- Expenses and losses from a federally declared disaster, if the employee lived or worked in the disaster area
What has changed in recent years
The Bipartisan Budget Act of 2018 and 2019 IRS regulations made hardship withdrawals easier to administer:
- Plans can no longer suspend an employee's contributions for six months after a hardship withdrawal.
- Employees are no longer required to take available plan loans first.
- Plans may allow earnings on elective deferrals, and certain employer contributions, to be included in the amount available.
The SECURE 2.0 Act added an option for plans to rely on an employee's written certification that the need is one of the safe harbor reasons, that the amount requested is not more than needed, and that the employee has no other reasonably available means to cover it. That can reduce the paperwork burden on employees and administrators.
Tax treatment
Hardship withdrawals are generally included in taxable income. If the participant is under age 59½, a 10% additional tax may apply unless an exception covers the situation.
Hardship withdrawals are not eligible rollover distributions. That means they cannot be rolled into an IRA or another plan, and they cannot be repaid to the plan later. They are generally subject to 10% default federal withholding, which participants can adjust.
Employees should understand these consequences before requesting a withdrawal. A $10,000 need can require a larger withdrawal once taxes are considered.
Alternatives worth knowing
Depending on plan design, employees may have other options:
- Plan loans, which are repaid and do not trigger taxes if the loan rules are followed
- Emergency personal expense distributions, an optional SECURE 2.0 feature allowing up to $1,000 per year for unforeseeable or immediate emergency expenses, exempt from the 10% additional tax and repayable within three years
- Qualified disaster recovery distributions, which have their own limits and tax treatment for employees affected by federally declared disasters
- Emergency savings accounts linked to the plan, another optional SECURE 2.0 feature
Sponsor responsibilities
Even with self-certification, the plan must follow its document. Your recordkeeper typically processes requests, but you should confirm:
- The plan document reflects the hardship rules the recordkeeper is applying
- Required records are kept, since IRS examinations often review hardship substantiation
- Payroll does not suspend contributions after a hardship withdrawal
It is also worth watching trends. A rising number of hardship withdrawals can signal financial stress in the workforce, which may point to a need for financial wellness education or emergency savings options.
Design decisions
When setting or reviewing your hardship provisions, consider:
- Whether to allow hardship withdrawals at all
- Which contribution sources are available
- Whether to use self-certification or require documentation
- How to explain the tax consequences to employees before they apply
Want a second look at your plan's withdrawal provisions? Brian Williams, CPFA®, of Northshire Consulting LLC | Registered Investment Advisory Firm meets with business owners to review plan design. Call 203-401-6062, email bwilliams@northshireconsulting.com, or visit northshireconsulting.com to schedule a plan review.
Frequently asked questions
Can an employee take a hardship withdrawal to pay off credit card debt?
Not under the safe harbor reasons most plans use. General debt repayment is not on the list.
Do employees have to stop contributing after a hardship withdrawal?
No. The six-month suspension of contributions was eliminated, and plans can no longer impose it for hardship withdrawals.
Can the money be paid back to the plan?
Generally no. Unlike a loan, a hardship withdrawal is permanent, with limited exceptions for certain disaster-related distributions.
This material is for educational purposes only and is not individualized investment, tax, or legal advice. Advisory services are offered through Northshire Consulting LLC | Registered Investment Advisory Firm.