The dollars you're secreting into your 401(k) employer-sponsored retirement plan occasionally are needed before you get your gold watch, and a hardship withdrawal may be the answer.
While not all 401(k)s are set up by employers to offer hardship withdrawals, many do offer this option. Depending on the circumstances, which include the plan rules, as well as IRS regulations, withdrawal may be offered without the tax penalties normally incurred if someone pulls money before age 59 and a half,
according to Bankrate. However, sometimes withdrawals will incur a 10 percent tax penalty.
According to an Investment Company Institute study from 2000, quoted on the
401KHelpCenter.co website, 48 percent of the people who have taken hardship withdrawals bought homes, while 28 percent used the money for medical emergencies, 21 percent for bills or daily expenses, and 7 percent for education.
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But here are some things to take into consideration before pulling money out of your retirement savings:
1. Check the requirements: Check the conditions set up in your plan to determine the definition of "hardship."
"For example, a plan may provide that a distribution can be made only for medical or funeral expenses, but not for the purchase of a principal residence or for payment of tuition and education expenses,"
reports the IRS.
"In determining the existence of a need and of the amount necessary to meet the need, the plan must specify and apply nondiscriminatory and objective standards."
2. Only for immediate and heavy financial needs: The IRS considers hardship distributions from 401(k)s to "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," their website stated, adding that the employee's spouse, dependent, non-spouse or non-dependent beneficiary may also meet the qualifications for a hardship withdrawal.
"A distribution is not considered necessary to satisfy an immediate and heavy financial need of an employee if the employee has other resources available to meet the need, including assets of the employee's spouse and minor children," the IRS added.
3. Explore other avenues: Before considering pulling from your retirement fund, consider other options, advises Bonnie Kirchner in her book "Who Can You Trust With Your Money?"
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"There are three levels of liquidity. People should have an emergency fund. The next level is investment accounts. And the next is retirement accounts,"
Kirchner tells Bankrate.
"Even though (a retirement account) is a source of liquidity in an emergency, they should really try not to touch it."
4. Penalty-free, not tax-free: Be aware that you likely have to pay taxes on the withdrawal, hardship or not. "Note that penalty-free does not mean tax-free. All traditional IRA and 401(k) withdrawals require that you pay taxes at ordinary income rates," reports Bankrate.
"Contributions to a Roth IRA can be taken out at any time, and its earnings may be withdrawn penalty and tax-free after five years."
5. Decision affects your retirement: Don't make the decision lightly,
cautioned the Milliman company, because it affects your retirement.
"One of the biggest consequences of taking a hardship withdrawal is something that participants rarely consider: the lost opportunity of compounding interest earned over time," the actuarial company said.
"By applying the time value of money theory, the idea that a dollar today is worth more than a dollar in the future because of its potential earning power, participants could be missing out on thousands of dollars at retirement."
The company cited an example of a man taking a withdrawal of $15,484.62 at age 30, and determining that cost him $194,000 at retirement, on average.
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