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401(k) Tip |
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Not all plans permit distributions from 401(k) accounts because of hardship. Ask your employer if hardship withdrawals are allowed.
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What Hardship Costs
A hardship withdrawal costs you any future earnings you might accumulate on the amounts you take out of your plan account. In most cases, you will also owe income tax and possibly a 10 percent tax penalty on early distributions on your withdrawal.
You can take hardship withdrawals from either a traditional or Roth 401(k) account, if your employer plan allows them. If you take your withdrawal before age 59 ½, you must pay an additional 10 percent penalty. The IRS grants several exceptions to the age rule, such as if:
- You are disabled
- Your medical bills exceed 7.5 percent of your adjusted gross income
- You are under court order to pay funds to a spouse, child or dependent
- You have been permanently laid off, terminated, quit or took early retirement in the same year you turn 55
Withdrawing from a Traditional 401(k)
If you take your hardship withdrawal from a traditional, tax-deferred 401(k), IRS rules say the distribution must come from your pretax contributions. The only exception is if you began contributing before 1989. Then you might also be able to withdraw earnings credited to your account before December 31, 1988, if your plan permits. You owe tax on the full amount you withdraw.
For example, if you’re in the 25 percent tax bracket and you withdraw $40,000 you have contributed, you’ll owe $10,000 in federal income tax, plus any state or local income tax that might apply. If you’re not yet 59 ½ or don’t qualify for an exception, you’ll also owe an additional $4,000 federal tax penalty. Based on the amount you take out, it's also possible that your withdrawal could move you into a higher tax bracket. In this example it could mean that some or all of the $40,000 could be taxed at the 28 percent rate. That would increase what you owed in federal income taxes to as much as $11,200 plus any tax penalty that was due.
Withdrawing from a Roth 401(k)
Hardship withdrawals from a Roth 401(k), on the other hand, include some after-tax contributions and some earnings. The specific amount you must take from each source is determined by how much you’ve contributed in relation to your total account balance.
For example, if you have contributed $20,000, accumulated $5,000 in earnings, and take $10,000, as a hardship withdrawal, $8,000 would come from contributions and $2,000 from earnings. (Since 80 percent of the account value is contributions and 20 percent earnings, then 80 percent of the withdrawal is contributions and 20 percent earnings.)
Income tax is due on the earnings portion of your withdrawal if:
- You are younger than 59 ½, in which case the 10 percent penalty also applies unless you qualify for an exception
- You are at least 59 ½ but your account has not been open for at least 5 years
However, if you are at least 59 ½ and your account has been open at least 5 years, the hardship withdrawal is tax free.
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