401k Hardship Withdrawal and Accessing Loans from Your 401k Plan

Image showing how you can access a 401(k) loan A 401(k) retirement plan is meant for your retiring years when you are no longer working and will rely on this income to support your standard of living. However, there are always circumstances in life when you have no choice but to tap your 401k account. Such a case would be termed as a '401k hardship withdrawal' and there are many rules surrounding this feature.

For this reason, the government allows 401k administrators to allow investors to borrow loans from their 401k plans. Be sure to check with your 401k administrator whether a 401k loan is available, as it is not mandatory for them to provide this service. The main advantage of a 401k loan is that the funds are not subject to taxes and the 10% early withdrawal penalty. However, if you default on the payment terms, then you might have to pay a 10% penalty.

Some restrictions set by 401k administrators include a minimum $1000 borrowing balance, as well as the number of 401k loans outstanding at any given time may be restricted to 1 or 2. This is done so as to reduce administrative costs. Also be aware that some 401k plans require married people to get the consent of their spouses in writing before they will hand out the 401k loan. This is because borrowing from the 401k plan is a mutual decision and could affect the lives of both spouses.

401(k) Loan Limits

Investors can borrow 50% of their retirement funds, up to a maximum of $50,000. If an investor has borrowed from the 401k plan in the previous 12 months, he will be allowed an additional loan to a maximum of $50,000 minus the amount borrowed from the previous loan. Both 401k loans in this circumstance must be paid back in 5 years, with the exception of home purchases which qualify for a longer repayment period.

Interest on 401(k) Loan

You must pay interest charges on the funds you borrow from your 401 (k) plan. Interest rate is set a prime rate + 1% or 2%. What makes 401k loans very interesting is that the interest you are paying goes back to your retirement nest egg, which helps grow your total balance. This is a lot better than paying interest to the banks. Also, the interest payments you make now will be reimbursed to you upon your retirement.

401(k) Hardship Withdrawals

If your 401(k) plan does not offer the feature of loans, it may still be possible for you to access urgent cash if you meet all of the following 4 criteria.These criteria are for 401k hardship withdrawals, which are only meant for cases of extreme hardship.

i) The withdrawal is due to current severe financial need.

ii) The withdrawal is meant to satisfy this need (this means you are not able to access cash elsewhere)

iii) The amount of the loan does not exceed the amount of need

iv) You have already accessed all distributable and non-taxable loans available under your 401(k) plan. If all of the above 5 conditions are satisfied, then investors can borrow 401k loans and use it for any of the following purposes:

a) Purchase of primary residence

b) To prevent home foreclosure or eviction from your home

c) Severe financial hardship

d) Tax-deductible medical expenses that are not reimbursed to you by your insurance company

e) Higher education expenses including room and board for you, your spouse, your dependents or children.

Note that all 401k hardship withdrawals are subject to 10% early withdrawal penalty as well as local state and federal taxes. Another disadvantage is that you do not have to repay back 401k hardship withdrawals to your account.

Non-Financial Hardship 401(k) Withdrawals

The 10% early withdrawal penalty on 401k withdrawals can be waived if you meet 1 of any of the 5 criteria below:

i) You become totally disabled (mentally or physically)

ii) Your medical debts exceed 7.5% of your Gross adjusted income

iii) The courts have ordered you to make payments to your spouse, children or dependents due to divorce or other settlement

iv) You are fired or permanently laid off in the year you turn 55

v) You are fired or permanently laid off and have a payment schedule of regular distributions for the rest of your expected life. Once such a withdrawal is taken, the investor is expected to take these withdrawals regularly for the next 5 years, until he turns 59 and 1/2 years old.