If times get tough due to an unexpected expense, you could get some financial relief with a hardship distribution. If you’re a member of an eligible retirement plan (like peppermint), a withdrawal of funds could be possible.
But there’s a catch. The IRS outlines some pretty strict criteria that must be met to qualify for a withdrawal, and there are some confusing tax laws associated with them. So, to prevent uncertainty and stress from getting to you, we’ve summarized everything you need to know about a hardship distribution in this blog.
What Are Hardship Distributions?
According to the IRS, a hardship distribution is a withdrawal from a participant’s elective deferral account. But the key difference with this type of withdrawal is that it has to do with ‘an immediate and heavy’ financial need.
The amount being withdrawn also needs to be limited to the amount of the expense; participants can’t withdraw more than needed.
It’s also important to note that some plans don’t allow hardship distributions, but peppermint does allow these emergency loans.
What Counts as an Immediate and Heavy Need?
Withdrawals are usually considered ‘necessary’ if they aren’t greater than the amount of the expense (including necessary tax). The employee would also need to exhaust all other financial options to have a withdrawal approved.
In traditional retirement plans, it’s ultimately up to the employers and the plan to determine if a participant has an ‘immediate or heavy’ financial need. So, even if your plan offers the withdrawal, you might not be allowed to make one, which is why it’s important to understand and review the terms of your plan. If your plan is with peppermint, we facilitate the hardship distributions for employees.
6 Types of Needs
As defined by the “Summary Substantiation Method”, there are six types of hardship distributions that are immediately considered to be ‘heavy financial needs.’
These include the following:
- Medical expenses (for the employee, the employee’s spouse, dependents, or beneficiaries).
- Costs related to the purchase of a principal residence (but not for payments on a mortgage).
- Tuition or related educational fees (to be for the next twelve months of post-secondary education).
- Funeral expenses (for the employee, their spouse, children, dependents, or beneficiaries).
- Repair costs for home damage.
- To prevent the eviction of the employee from their principal residence (or to prevent a foreclosure on the mortgage on that residence).
Even if your unexpected expenses fall into one of these pre-approved categories, your employer or peppermint will need specific information (and possibly documentation) to prove the hardship. Therefore, it’s critical to keep on top of all these expense receipts at the risk of being denied.
Another stipulation of a hardship distribution is that it must be limited to the amount of money necessary to satisfy the need.
It’s also the employee’s responsibility to see if they could have obtained the funds from another source. This could include receiving money from another insurance or reimbursement plan, a liquidation of assets, employee pay (by discontinuing elective deferrals and after employee tax contributions), plan loans, or reasonable commercial loans.
To ensure an employee has investigated other options, peppermint requires the employee to sign a written statement as proof.
There is one circumstance, though, where an employee doesn’t have to use alternative resources. If an employee has alternative funds but accessing them would increase the amount of their need, they can make a withdrawal. For example, this would occur if a distribution disqualified the employee from obtaining financing for a property loan.
A hardship distribution can be made from elective deferrals or from the pre-approved amount that the employee has been contributing directly to the retirement plan from their salary (as defined by the IRS).
The distribution can also be made from non-elective contributions (also known as ‘profit-sharing contributions’) and regularly matched contributions. But these withdrawals can only be made when your employer or peppermint allows them.
If your employer or peppermint approves the withdrawal, you’ll be able to keep contributing to the retirement plan and will still be eligible to receive the employer’s matching contribution.
Any distribution withdrawals are taxable. So, if you do need to make a distribution, understand that it will be subject to income tax on the amount.
Additionally, it may be subject to a 10% 10% additional tax. This tax will be applied if you are younger than 59 ½. If you are in that age group, you’ll be subject to the 10% penalty, unless you are receiving the funds under the IRS’s specific circumstance (for example, if it’s for a corrective distribution, a death, a disability, or if there’s a qualified domestic relations order, etc.)
Should You Make a Withdrawal?
Prior to making a withdrawal, it’s important to analyze your current financial situation. If better options don’t exist, and you’ve exhausted all other financial avenues, a hardship withdrawal could make sense for you.
But it’s important to keep in mind that 401k money is shielded from creditors and protected from bankruptcy. So, if you think you might end up filing for bankruptcy, you might want to reconsider pulling cash out of it.
Plus, the provisions in each individual 401(k) plan determine whether hardship withdrawals are even allowed. So, it’s up to you to ensure the plan provides one.
You may want to consider speaking with the plan administrator for more information on what is eligible for you. Alternatively, you can request a copy of the summary plan description agreement from the employer. This will include information about when (and under what circumstances) withdrawals can be made.
Ultimately, if borrowing isn’t an option, you understand the implications, and your plan allows it, a hardship withdrawal could be right for you.
Regardless, it’s always best to speak with a financial professional so you can explore all your options first.
Learn more about what perks the plan options include at peppermint.
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The peppermint blog assumes no responsibility or liability for any errors or omissions in the content of this site. The information contained in this site is provided on an “as is” basis with no guarantees of completeness, accuracy, usefulness, or timeliness. It does not represent or replace actual financial advice provided by a certified financial professional. Since everyone’s situation is different, we always recommend addressing specific questions to your plan provider or certified financial professional. As such, peppermint may not be held liable for your use or reliance on any information contained herein.