Hardship Withdrawals – IRA vs. 401(k): What’s the Difference - and Should You Do It?

When facing a financial emergency, it’s tempting to turn to your retirement savings for help. One of the ways to access funds early is through a hardship withdrawal. While both IRAs and 401(k) plans may allow for this type of withdrawal to provide short-term relief, there are some differences between the two, and both may result in unintended long-term consequences. Understanding how each works as well as learning what your alternate choices are can help you make a more informed decision about protecting your retirement future.

What Is a Hardship Withdrawal?

A hardship withdrawal allows you to permanently withdraw money from your 401(k) or other employer-sponsored plan due to an “immediate and heavy financial need.” These distributions are typically limited to the amount necessary to meet that need, are taxable income, and may be subject to a 10% penalty if you are under 59½ unless you meet qualifying exemptions. Unlike a loan, this money is not repaid to your account, and you must stop making contributions for at least 6 months after the withdrawal, so your retirement savings permanently shrink. Not all employer plans allow for this type of withdrawal, so you would need to review your Summary Plan Description to see if this is an option for you. 

What are the Qualifying Exemptions from a 401k/403b?

Under IRS “safe harbor” rules for plans such as 401k and 403b, a hardship withdrawal may be allowed for specific expenses without the 10% penalty, including:

• Medical expenses for you, your spouse, dependents, or beneficiary
• Costs to purchase your primary residence (excluding mortgage payments)
• Tuition, fees, and room and board for post-secondary education if allowed by plan
• Preventing eviction or foreclosure
• Funeral expenses for close family members
• Certain expenses to repair damage to your principal residence, such as from a natural disaster
• Qualified Domestic Relations Order (QDRO) 

What About Early Withdrawals from an IRA?

While not technically known as a “hardship withdrawal”, IRAs do allow for some exceptions to the early withdrawal penalties that would normally be assessed for removing funds prior to age 59½, resulting in essentially the same outcome. The withdrawal is also taxable (unless it comes from a Roth’s post-tax contributions), but does not limit your ability to contribute in the future. In general, the exceptions allowed are as follows:

• Disability and Death
• Unreimbursed medical expenses greater than 7.5% of your AGI
• Distributions for victims of domestic abuse up to $10,000
• Withdrawal for personal or family emergency expenses up to $1000 per year

• Qualified birth or adoption withdrawal of $5000

• Qualified first-time home purchase (up to $10,000)
• Qualified higher education expenses for yourself, your spouse, your children, or your grandchildren
• Health insurance premiums if unemployed

Alternatives to Hardship Withdrawals

So now you know that you CAN tap into your retirement funds… should you? Because of the potential for long-term consequences (like permanently decreasing your retirement savings and paying increased taxes while you’re already suffering an economic hardship), you might want to explore these less costly options first:

1. Emergency savings: Ideally your first line of defense. At Axiom Wealth Strategies we recommend having 3-6 months of living expenses saved in an easily accessible on-demand account such as checking, savings, or money market account. Make it a priority to “pay yourself first” by systematically putting a small amount of money into an account each month until you reach this goal.
2. Roth IRA contributions: You can withdraw your direct contributions (not earnings) tax- and penalty-free anytime. This will still affect your long-term retirement savings, but with far less risk and cost overall.
3. Personal loan: May offer lower interest rates without jeopardizing retirement growth.
4. Employer or community assistance programs: Some companies offer short-term hardship grants or payroll advances.

Final Thoughts

Using your retirement savings for emergencies should always be a last resort. Hardship and early withdrawals can have lasting effects on your financial future. Before making a decision, talk to a qualified financial planner who can help you weigh your options and find the least damaging solution for your long-term goals. If you want an advisor that can help you through all of life’s ups and downs, give us a call at Axiom Wealth Strategies, and we can help you build a plan that keeps your finances (and your future) on track.