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Can You Take 401(k) Funds Early? - New Rules Make it Easier, But Should You?


Your company offers a 401(k) to save for retirementGreat! But what if you need those funds sooner? Accessing 401(k) money before retirement can be a challenge. For better or worse, the IRS has issued new rules that make it easier to tap those funds for other reasons. Here's what you need to know about the changes coming to 401(k) withdrawals starting in 2020.

What are hardship withdrawals?

As the name implies, hardship withdrawals are allowed by some 401(k) plans to allow participants to withdraw money early, before retirement, for unforeseen circumstances. While we don't suggest taking money from your retirement plan early, in a difficult financial situation there may no other choice. A hardship withdrawal can be a lifeline when there are no other options. 

What can you take a hardship withdrawal for?

While we hope you never need to take a hardship withdrawal, if you find yourself in this situation the new rules make doing so a little easier. Changes by the IRS broaden the reasons someone is allowed to take a withdrawal before retirement. Examples of these situations include:


  • Purchase of a primary residence
  • Expenses to repair a primary residence
  • Medical Expenses
  • Educational costs for post-secondary education (including for spouses and children)
  • Funeral expenses

The IRS also loosened the verification requirement by plan providers to allow a hardship withdrawal. The new rules stipulate that the distribution cannot exceed what the employee certifies that they need.The onus is on you to tell the provider the amount needed and that there are no other funds available to use. The provider is permitted to make the distribution so long as they don't have evidence to the contrary.  

What money can you take?

Under the previous rules, you could only access your own personal contributions. However, this has expanded to include earnings and employer matching or profit-sharing funds. Meaning, you have access to more funds in a time of need. 

What are the tax implications?

This is where taking a hardship withdrawal can get a little ugly. Unlike 401(k) loans (which may be another withdrawal option), hardship withdrawals are treated as a distribution, and thus taxable to you. In addition to that, if you're under the age of 59.5, you may be assessed an additional 10% early withdrawal penalty!

As an example, if you took out $10,000 as a hardship withdrawal, are in the 25% tax bracket, and are under 59.5 the amount owed for taxes would be $3,500. Leaving you with only $6,500 after taxes! A potential steep price to pay to access your money before retirement. 

Do you need to pay the money back?

Because this isn't a loan, the money can't be repaid back to the 401(k). You don’t even have that option. Once a hardship withdrawal is taken, it's gone, and the tax implications apply. This leaves you with less money available to grow for retirement. 

A slight reprieve to this is that under the new rules, you can begin contributing again right away. Previously you would have to wait at least 6-months before being allowed to contribute again. Thus missing any employer match and potential growth during that time. Assuming the emergency is short-term, being able to contribute again right away can negate some of the negative impact of taking funds out of your retirement plan. 

Should you take a hardship withdrawal?

The short answer. No . . . if you can avoid it. Sometimes life throws you curve balls and this may realistically be your only option. The loosening of restrictions can be a godsend for those who truly need these funds. However, when considering the tax impact, potential penalty, and depletion of funds set aside for retirement, taking a hardship withdrawal is rarely a good decision long-term. 

The best way to avoid need to take a hardship withdrawal is being prepared for these emergencies before they happen. Since we don't know when an emergency will happen we suggest setting aside 3-6 months’ worth of living expenses in a savings account. When an unexpected financial need arises, you'll already have funds set aside that will be available to offset the cost. 

But if you find yourself in a situation where you may need to tap your 401(k) early, it's best to speak with a financial professional. This way they can discuss the impact with you and review any other alternatives you may have missed. The last thing you want to happen is for this withdrawal to derail your retirement planwhen other options are available. 


1 https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/irs-final-rule-eases-401k-hardship-withdrawals.aspx