Here's the Internal Revenue Service's definition of a
401(k): "a tax-qualified deferred compensation plan in
which an employee can elect to have the employer contribute
a portion of his or her cash wages to the plan on a pre-tax
basis."
So, let's say you've got a nice 401(k) savings. What
happens if you need to withdraw that money?
Early distributions are those that are received before age
59 ½. To discourage them, early distributions are
subject to normal income tax plus a penalty of 10%
additional tax unless one of the following occurs:
1. You die or become disabled
2. Your employment ends and you roll over the
money directly to another qualified retirement plan
3. The plan ends for any reason including an IRS
levy and no other plan is established or continued
in its place
4. You need to pay for medical care up to the
amount allowable as a medical expense deduction
5. The distributions are part of a series of
substantially equal periodic payments over your
life expectancy after you no longer work for the
employer
Without one of these five conditions prior to reaching age
59 ½, the only way to withdraw money from your 401(k)
without having to pay it back is to qualify for a Hardship
Distribution.
So what qualifies as a financial hardship under the IRS's
rules? First of all, individual plans can vary greatly
from employer to employer.
If you own a business or manage a retirement account for
employees, you need to become familiar with your plan.
Many companies may have a 401(k) plan without really
understanding all the details.
So if you think you might qualify for a Hardship
Distribution from your 401(k), ask your employer if the
plan allows for these distributions at all.
Employers must adhere to the strict guidelines of their
plan documents and can not make loans or Hardship
Distributions if the plan doesn't allow for them.
If your employer doesn't know the answer or seems unwilling
to research this for you, ask them for a copy of the plan.
All participants are entitled to receive the plan document
in writing.
If your 401(k) plan does provide for Hardship
Distributions, here are the requirements:
(1) the withdrawal must be due to an immediate and heavy
financial need; (2) the withdrawal must be necessary to
satisfy that need (i.e. you have no other funds or way to
meet the need); (3) the withdrawal must not exceed the
amount needed by you; (4) you must have first obtained all
distribution or nontaxable loans available under the 401(k)
plan; and (5) you can't contribute to the 401(k) plan for
six months following the withdrawal.
The amount you can withdraw is usually limited to the
amount of your elective deferrals only. This would not
include any income earned on the deferred amounts or money
matched by the employer.
The following items are considered by the IRS as acceptable
reasons for a Hardship Distribution:
1. Medical expenses for you, your spouse, or dependents
2. Purchase of a primary residence or repair of a primary
residence
3. College tuition and related educational costs such as
room and board for the next 12 months for you, your spouse,
dependents, or children who are no longer dependents
4. Payments necessary to prevent eviction from your home,
or foreclosure on the mortgage of your principal residence.
5. Funeral or burial expenses for immediate family members.
You do not have to pay the withdrawal amount back to the
401(k) account. However, as I mentioned previously, you
can't contribute to the 401(k) plan for six months
following the withdrawal.
So when investing in a retirement account don't think of it
as a regular savings account. You won't be able to get
that money back into your hands before age 59 ½
without a significant penalty or hardship that you can
prove.
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Laura Adams is the host of the popular MBA Working Girl
Podcast. The content combines brainy business school theory
with real-world business practice from her career as a
business owner, manager, consultant and trainer. Subscribe
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