NataliePace.com Home Page Article
Can You Take a Hardship Distribution From
Schwab-Pomerantz, CFP®, President, Charles Schwab
Foundation; Senior Vice President, Schwab Community Services, Charles Schwab
& Co., Inc.
May 16, 2012
I'm 57 years old
and unemployed. I have $250,000 in a 401(k). Can I withdraw some of the money
While it sounds like you're
experiencing a tough time, your age and the size of your 401(k) mean that you
do have some options for getting though it. If you were employed, my first recommendation
would be a 401(k) loan. That way you could access some of your assets without
paying income taxes and a possible penalty on your distribution. Unfortunately,
a 401(k) loan isn't allowed once you leave a company.
As you suggest, a hardship
distribution is another possibility, although what's considered a hardship is
very specific—and the cost in taxes and penalties can be formidable. Fortunately,
there are other alternatives for someone in your situation.
into separation of service
You don't say
when your employment status changed, but if you left or lost your job in the
year you turned 55 (or later), you could consider a distribution from your 401(k)
under what's called separation of service. This allows you to take an early
distribution without paying a penalty, although you will have to pay income
taxes on it.
taking Substantially Equal Periodic Payments
If you left your
company before age 55, you can still set up a schedule of "substantially equal
periodic payments" and avoid the 10 percent penalty. Determined by your life
expectancy and an interest rate approved by the IRS, withdrawals must be taken
for a minimum of 5 years or until you reach age 59˝, whichever is longer. So
if you started taking them now at 57, you'd have to continue until age 62. After
that, you could take unlimited amounts from your 401(k) penalty-free.
about a rollover IRA
is to roll over your 401(k) into an IRA. This could actually mean more investment
choices and lower fees. Rolling over can be a fairly simple, no-cost process,
but you must be sure to roll your 401(k) directly from your employer to your
IRA. If you take possession of the money, timing rules and possible penalties
come into play. And the IRS also allows you to take a distribution from an IRA
in substantially equal payments with no penalty at any age.
what to do if you have company stock
If you have appreciated
company stock in your 401(k), there's another possible course of action. You
don't have to roll this stock over into an IRA and pay ordinary income tax rates
when you withdraw it. Rather, you could transfer the stock to a taxable account
and take advantage of what's called net unrealized appreciation. With this strategy,
you generally pay taxes only on the cost basis of the company stock (its value
when you received it), which could be significantly lower than the current value.
Then when you sell, you pay long-term capital gains taxes, not ordinary income
a hardship distribution a last resort
a hardship distribution from your 401(k) isn't easy. First, you must prove what
the IRS considers "immediate and heavy financial need." In general, the IRS
defines this as:
- Medical expenses for
you, your spouse or dependents
- Costs directly related
to the purchase of your principal residence (excluding mortgage payments)
- Post secondary tuition
and related educational fees, including room and board for you, your spouse
- Payments necessary to
prevent you from being foreclosed on or evicted from your principal residence
- Funeral expenses
- Certain expenses relating
to the repair of damage to your principal residence
The amount of the distribution
is limited to your own contributions to the plan and possibly your employer's
contributions but doesn't include earnings or income on your savings. It also
can't be for more than the amount of the specific need—and you can't have other
resources available to cover it.
Another big negative is
that even if you qualify for a hardship distribution, you'll have to pay both
income taxes and a 10 percent penalty. To me, this like rubbing salt in
And finally, another possible
snag is that while the IRS allows hardship distributions, not all plans do.
Some only allow them under very limited circumstances, for instance to prevent
a foreclosure but not for education expenses. Also, a retirement plan isn't
required to allow such distributions once you're no longer working for the company.
specific tax advice
My main concern
for anyone who wants to tap into retirement assets early is how it will affect
financial security later on. Remember, you're not only depleting your hard-earned
savings, you're also losing the potential for tax-deferred growth.
But sometimes, present
concerns have to trump future possibilities. If your 401(k) is your only recourse,
I strongly urge you to talk to a tax or financial advisor before taking action.
Get information specific to your situation—and only withdraw as much as you
need to keep yourself afloat until things turn around.
The information provided here is for general informational purposes
only and is not intended to be a substitute for specific individualized tax,
legal or investment planning advice. Where specific advice is necessary or appropriate,
consult with a qualified tax advisor, CPA, financial planner or investment manager.