Lewes CPA
officeProgar & Company, P.A.
Certified Public Accounting services for businesses and individuals
Hardship withdrawals and loans from 401(k) plans (MS Word)
Hardship withdrawals and loans from 401(k) plans (.pdf)
Hardship withdrawals and loans from 401(k) plans
Dear Reader:
If you participate in your company's 401(k) plan, the value of your
account balance may well be your most significant financial asset.
And if you happen to be facing, or anticipate facing, major
financial obligations, you should be aware of the possible ways you
can tap this source of funds while you're still working and a plan
participant.
Generally, distributions from a 401(k) plan while you're still
employed and before you reach age 591/2 are not permitted. However,
if you have an unusual financial obligation and an immediate need
for cash, you may be entitled to a distribution from the plan. If
your plan provides for hardship distributions, and you can show that
you have an immediate and heavy financial need, then you may be
entitled to a distribution of funds necessary to meet your
obligation. There are regulations which spell out what is an
immediate and heavy financial need. Included in this category would
be funeral expenses for a family member, for example. On the other
hand, a distribution for the purchase of a boat or a television
wouldn't be a distribution on account of an immediate and heavy
financial need.
There's a limit on the amount you can take out of your 401(k) plan
due to hardship. Hardship withdrawals are limited to amounts
attributable to elective contributions to the plan. These are the
amounts that you have elected to have your employer contribute on
your behalf into the 401(k) plan, and any earnings on these amounts.
You should be aware that hardship withdrawals are taxable
distributions, and if you're under age 591/2 , you may be subject to
a 10% addition to tax on premature distributions.
Special rules apply to the withdrawal of any “after-tax,” or
voluntary contributions, you may have made to your plan. These
amounts can be withdrawn while you're still working. However, these
distributions will be taxed under a formula that excludes from
income a pro-rata portion calculated with reference to your
after-tax contributions as they relate to the total value of your
account.
Another way to get cash from your 401(k) plan is through a plan
loan. A plan loan is ordinarily a taxable distribution, but if your
plan provides for loans and certain conditions are met, you could
receive the funds tax-free. There is a five-year repayment
requirement, interest on the loan will ordinarily be nondeductible,
and the amount of a plan loan is limited to 50% of the value of your
nonforfeitable accrued benefit—generally your vested benefit—with a
limit of $50,000. The five-year repayment requirement doesn't apply
if the loan is for the purchase of a residence. Unlike a taxable
hardship distribution, a plan loan doesn't require that you
establish an immediate and heavy financial need. Your ability to
borrow from your 401(k) plan depends on requirements under the terms
of the plan.
Another point to keep in mind is that a plan loan—unlike a hardship
distribution— doesn't reduce the value of your 401(k) assets. Your
account remains fully vested, subject, of course, to your obligation
to repay the loan.
We would be happy to meet with you to discuss the pros and cons of
these options in greater detail.