Hardship withdrawal

What a hardship withdrawal is

A 401(k) plan may, but does not have to, let current employees withdraw money for a hardship. The IRS requires two things: the employee has an immediate and heavy financial need, and the amount is no more than needed to meet it, including taxes on the withdrawal.

Most plans use the IRS list of needs that automatically qualify:

• Medical expenses for the employee, spouse, dependents or beneficiary.

• Costs of buying a principal residence, not counting mortgage payments.

• Tuition and related fees for the next 12 months of post-secondary education.

• Payments to prevent eviction from, or foreclosure on, a principal residence.

• Funeral expenses.

• Certain repairs to a principal residence after a casualty.

• Losses from a federally declared disaster.

Why it matters to employers

The plan administrator has to approve each request under the plan’s terms, so you need a consistent process. SECURE 2.0 lets a plan rely on the employee’s written certification that the need qualifies and the amount is not excessive, unless the administrator knows otherwise. Plans can no longer suspend an employee’s deferrals after a hardship withdrawal.

Tax treatment

A hardship withdrawal of pre-tax money is taxable income. A 10% additional tax usually applies if the employee is under 59½. It cannot be rolled over to an IRA or repaid to the plan.

Common mistakes

• Paying a hardship from a plan whose document does not allow them, or from a money type the document excludes.

• Approving requests for needs that are not on the plan’s list.

• Keeping no record of the request and certification.

• Still applying a six-month deferral suspension from old procedures.

• Not telling the employee that a plan loan, if available, avoids the tax.