401(k) Hardship Withdrawals Spiking – Rules and Alternatives

by Darwin on August 20, 2010

401(k) Hardship Withdrawals are spiking, according to Fidelity, one of the nation’s largest retirement account administrators.  According to their report, the number of such transactions is at a 10 year high.  While alarming, this should not come as a surprise as a confluence of factors have contributed to a lack of options for people – layoffs, losses in other investment accounts, and the notion that people can no longer use their home equity as a piggyback via cash out refinancing since so many homes are underwater.

401(k) Hardship Withdrawal Data

  • 62,000 people initiated withdrawals compared to 45,000 a year ago
  • A whopping 45% that did one last year did another this year

In order to execute a hardship withdrawal, you need to qualify via IRS regulations for things like medical expenses and demonstrate immediate financial need.  A surprising number of circumstances meet the criteria as well including foreclosure prevention, funeral expenses and tuition expenses.

Upon doing so, if under 59 1/2, you’ll incur a 10% excise tax.  As long as you’re still employed and have a sizable 401(k) balance, as I highlighted over at Darwin’s Finance, I would actually recommend taking out a 401(k) Loan rather than a flat out withdrawal.  As opposed to paying a 10% tax to the government upon withdrawal under the hardship clause, in the loan scenario, you will pay a rate of probably 4-5% back to yourself!  The interest goes back into your account.  The argument about double taxation is rather bogus since any loan interest (excluding mortgage above the standard deduction) is paid back with after-tax dollars anyway.

While it’s optimal to avoid touching your retirement funds until retirement and hit those 401(k) contribution limits, today’s reality might be the choice between being able to remain in a home, pay for food or just hold you over until you start a new job.  Some additional considerations which may deter you might be that you’re unlikely to collect the Social Security benefits you may have assumed previously, with the Social Security retirement age moving to 70 if politicians get their way (and from a pragmatic standpoint, it’s somewhat necessary).  Considering your social security strategy, much may have to do with what sort of pension you expect in your retirement years as well.  In some cases, some action is mandatory and there aren’t many alternatives.  If presented with the choice between a hardship withdrawal and a loan, I’d opt for the loan.

Do You Know Anyone Doing a 401(k) Hardship Withdrawal?

{ 1 comment… read it below or add one }

Financial Samurai August 21, 2010 at 10:10 am

What about just hardship borrowing in the sense you borrow and pay yourself back at whatever rate?

Frankly, I’d withdraw out of my 401K if I had no choice either.


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