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What to Know About 401(k) Hardship Withdrawals

Life’s unexpected events, such as the Coronavirus pandemic, can throw a wrench in even the best-laid plans. After over a year of lockdown and other restrictions, you may have tapped into savings accounts and emergency funds for additional cash.

Unfortunately, after these resources become depleted you may have no choice but to look towards retirement savings. Yet, these account withdrawals often come with costly short-term and long-term penalties. If you have a 401(k), you can make a “hardship withdrawal” for specific expenses. What should you know about this important financial decision?

Are You Eligible?

As defined by the IRS, a 401(k) hardship withdrawal is an early distribution to pay for an immediate and heavy financial need. Each 401(k) plan has its own qualifications for hardship withdrawals, so it’s important to review your documentation. The rules may differ by plan but potential needs include:

  • The purchase of a home, excluding mortgage payments
  • To avoid foreclosure or eviction
  • To pay for home damage caused by a natural disaster
  • College tuition
  • Medical expenses

Pay attention to policy changes, particularly during times of national crisis. For instance, the Coronavirus Aid, Relief and Economic Security (CARES) Act made it easier for those affected by COVID-19 to take hardship withdrawals without penalty in 2020.

Potential Downsides

Financial experts typically recommend a 401(k) hardship withdrawal as a “last resort” for cash. Depleting your retirement savings can have long-term effects, considering the IRS has limits on the amount you can contribute each year. Depending on the size of the withdrawal, you may not be able to rebuild your account right away. If you are close to retirement age, this might not be the ideal option. There is also a penalty fee, typically 10 percent, plus taxes.

An Alternative Solution

If you or your partner has a Roth IRA, start with this account first. Withdrawals can be made from Roth IRA accounts at any time without penalty. Since you’ve already paid taxes on your contributions, you will not be taxed on any withdrawals.

To learn more about retirement savings and other financial strategies, contact Ion Bank.

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