Emergency 401k Withdrawal

Factual Questions
1

My wife and I are in a tight financial spot. She’s been unemployed since being laid off just about a year ago. There are indications that things are loosening up in her field, and she has real prospects coming up in a couple of months, but she hasn’t found anything yet. We’ve got a mortgage, and when she became unemployed, I added her to my health insurance plan at a cost of more than $6,000 per year. Nonetheless, there have been expensive health problems that my insurance will not cover. So that’s been another drain. Plus, my industry isn’t doing that well, and I’ve had to take a cut in pay. So we’re a very, very short while away from total disaster, losing our home and everything else.

I have a 401k plan. There’s a fair amount of money in there. If I could withdraw some of it (not even close to most of it – just enough for the next couple of months), we’d be OK. But the company that runs the plan (Fidelity) and the person at my company who is in charge are telling me that withdrawals are not permitted. I can’t borrow from it – I already did that, to the limit, when we bought our home.

Does anyone know of any way around this? This is the only chunk of change I’ve got, and I have nowhere else to go. I’m hoping there’s some way – otherwise we’re in serious trouble, starting right about now.

Any advice greatly appreciated.

2

If you are saying that you already have a 401(k) loan and your plan doesn’t allow hardship withdrawals, then the only way to take a distribution is to terminate your employment. Plans are designed specifically to avoid allowing people to take out money, so there really is no way around it.

3

Disclaimer: I am not a lawyer nor an investment counselor nor a Human Resources specialist. But I have taken loans against my 401K.

It depends on your 401K. Some will allow you take a loan or two against the money in your fund (up to a certain limit, say 50% of your funds) for any reason whatsoever. In other plans there are limited conditions under which you can take a loan.

If your 401K is administered by your employer, call your HR director and find out what the options are. Better yet, if your 401K plan affords you on line access (most do these days), sign up on line to manage your account. They will tell you about your plan, whether or not a loan is allowed, under what conditions you can take a loan, and how much you can take. With on line account management you don’t need to go to your HR folks; you can arrange for the loan via the website and the money is usually moved to your personal checking/savings account in a week or so via direct deposit.

If possible, I would suggest you take a loan instead of cashing out a portion of the 401K. If you cash out you’re going to take a big tax hit up front; 20-30% of the money you request will go to the federal government (even though you’ll probably get a pretty good portion back as a refund). It will be considered taxable income for the year, and you will have to add this as income to both your federal and state (if applicable) tax returns. This means you may get part of the withholding back from the fed in the form of a refund, but will probably end up owing state income taxes on that money, since there will likely be no withholding taken out up front for state income taxes.

Also, with a loan, the interest rates are good and you can decide how aggressively you want to repay the loan; for example, do you want to repay it in 2 years, 3 years, 5 years? These may be some of the options that are allowed.

To recap, the possible options are:

  1. Sign up online to manage your retirement account (if that’s offered).
  2. Call or visit your HR department to see what your options are.
  3. Find out what company administers your plan (i.e. T Rowe Price, Prudential, etc.) and call them for information. I find these folks to be very helpful as a rule.

I can’t imagine that you wouldn’t qualify for a hardship loan regardless of what type of 401K you have. I know what it’s like to be out of work (been there, done that) and need money. I hope things improve for you very quickly.

All the best.

4

Well, just so you know, if you do manage to take money out, 20% will be withheld for minimum Federal income tax. When you file your income taxes an additional 10% will be required as a penalty for early withdraw.

The amount that you take out will be added as income to your taxable income during the year you take it out. And that will move you into a higher tax bracket than your paycheck with holdings were based upon for the year.

So the 20% automatic withholding won’t even come close to paying the actual amount you owe on the money at the end of the year, the 10% penalty is not withheld at the begining just in case you can replace the money in another tax defered account, so you have to pay that too at tax time. And you have to file with a total year end income in a tax bracket that you have not had enough taxes withheld from your pay.

As example, if you earn 40k per year and take out 40k you are going to be in the 80k tax bracket when you file your income taxes. If you have state or local income taxes add those into the mix on top. Plus the penalty. Your withholdings at your job were at the 40k rate. All the math ends up very badly for you.

The end result becomes a big ‘Oh Shit’ tax bill later that makes the whole idea a bad one.

5

I took a hardship withdrawal 3 years ago when my sister died. So did my Brother. We couldn’t just bury her in the back yard. So we did what had to be done. 20% was held for taxes and 10% penalty which was paid when we did our taxes. I got what was left in my return.

6

Some plans don’t offer hardship withdrawals. It is not mandatory. It sounds like yours doesn’t.

7

Talk to a bankruptcy attorney ASAP. They’ll offer a free consultation.

What most people do when facing bankruptcy is try to survive as long as possible without it. They refinance their home, tap their retirements and then realize that they still can’t get by so they go to file. That’s when they learn that homes and retirement plans are protected and that if they’d filed 6 or 12 months earlier, they’d have preserved tens of thousands of dollars in assets, wiped out a larger percentage of their debt and not had back taxes to pay (since you can’t clear those in a bankruptcy).

Seriously. Don’t take money out of your 401k unless the bankruptcy attorney says you should.

8

Even if your plan offers hardship withdrawals, the rules for what is considered a hardship are pretty stringent. If your hardship falls under one of the allowed categories, you also have to provide documentation supporting the request. For example, if you need help paying a medical bill, you need to provide copies of the bills you want help to pay and the dates on the bills have to fall within a certain range.

9

Some types of life insurance policies allow loans. Have you checked into that?

10

Technically, you just made a withdrawal from your 401k. A “hardship” withdrawal must meet certain types of criteria established by the IRS and permitted by your plan administrator. If it meets the “hardship” requirements you can then avoid the 10% penalty due to the hardship.

http://www.irs.gov/retirement/article/0,,id=162416,00.html#2

11

Burial and funeral expenses are considered hardship withdrawals. You can’t make any other type of withdrawal from your 401(k), with the exception of a loan.

12

Several of my employees have loaned themselves money from their company-sponsored accounts. There were limits on how much and the loans had to be repaid to the account with interest. As someone else has stated, I do not represent myself to be an expert in these matters, but I’d sure go beyond asking one Fidelity representative. Your accountant, maybe.

13

(Standard Disclaimer–I am not a financial advisor. I did, however, work for one of the larger providers of 403(b) contracts, and still work in annuities, though no longer primarily with group plans. Speak to your financial advisor before doing anything drastic. The basic backgroud I’m giving here, though, is born from that experience (and, believe me, you get a lot of talk time about loans), and should be as valid as it can be with only generalities instead of specific values/numbers.)

Loans aren’t withdrawals.

I cannot state this clearly enough. A loan is not a withdrawal.

Now, you’d think this would be obvious to people, but it isn’t. The loan has to be paid back. If you default on the loan, on the plans I’m familiar with you have to pay taxes on it. And, if you’re subject to the early withdrawal penalty, then it applies to that to. You get a nice little 1099R with a distribution code of 1 on it.

Thing is? It still isn’t your money. If you’re not eligible to withdraw money from the plan (you’re under 59 1/2, still working for the same employer, or disabled), then you have to pay it back. You’ll be credited your cost basis when you do eventually get to withdraw the contract, but the loan’s gonna continue accruing interest until you pay it back. And a hardship withdrawal cannot be used to pay off the loan, so that option isn’t open to you.

Now, it look like the OP has already taken the maximum loan on the contract. While financial hardship is technically allowed per the IRS, the company and the plan can set restrictions as to how much and when. Additionally, enough must remain in the contract to cover the loan plus collateral; if the OP’s maxed out the loan, it’s likely that the entire shebang’s tied up as collateral and can’t be used for hardship. IME, the only time I’ve seen hardship is when the individual has a small-to-middling loan that they’ve defaulted on. That keeps them from being eligible for additional loans, but also means they have money that isn’t tied up in collateral. Also, some plans might have other restrictions, such as only letting you take out what you put in, and not what the employer has matched with.

It sounds like you legitimately don’t have a hardship withdrawal–or any withdrawal available. It’s also likely that if you did try to close the account, the majority-or-all-of-it might go to paying the loan plus the mandatory withholding (it depends; the 401(k) I’ve seen administered only allowed you to take 50% as the loan. Most of the 403(b)s and 501©3 plans allowed for more than that).

I recommend what dracoi said upthread; hie thee to a bankruptcy attorney, or (if you have one, and the situation isn’t at that point) a financial advisor of some sort. What everyone’s giving you here is just speculation; someone who knows your plan and your assets is going to be a million times better.

14

Not even close, actually, but I’ve borrowed the maximum the plan permits. Less than a quarter of the amount in there.

That’s what they’re telling me – no withdrawal. It’s not that I’ve borrowed too much (again, not even close to the amount in there). Just that the plan doesn’t permit withdrawals.

As to it not being a hardship, perhaps not, as that word is defined by the plan or the law or whatever. But in my life? Drowning in mortgage payments, with an unemployed wife with serious health problems that our insurer won’t cover? Working my regular job (at which I had to take an $8,000 cut in pay this year due to my company’s difficulties), doing temp jobs at night whenever I can get them, not sleeping much, worrying all the time? Yeah, it’s a hardship.

I know. Time is so short, though – we’re really pressed. I was just clutching at straws.

Thanks for your advice, everyone.

15

No. My 401k allows for a hardship for burial, to prevent foreclosure, etc. I had to provide proof for the amount I needed. I had already had an outstanding loan which was the reason for the hardship withdrawal.

16

I would also suggest that the OP obtain a copy of the Summary Plan Description (SPD) for his plan. The SPD is document that describes all the plan features in plain English. It will tell you under what circumstances you may take money out of the plan. All plans are required to provide their participants with an SPD on request. Don’t rely on what someone in HR is telling you. They may or may not understand the plan properly.

Just nitpicking a couple things up-thread…since this is GQ.

Meeting the hardship requirements does NOT get you out of the 10% early withdrawal excise tax. Any early withdrawal (pre-59.5) that does not meet one of the few exceptions granted by the IRS, is subject to the excise tax.

Also, 20% federal withholding is typically not required on hardship withdrawals from 401(k) plans. A few years back, the rules were changed so that hardship withdrawals are no longer eligible to be rollover over to an IRA or other qualified plan, to the extent that the source of the withdrawal is the employee’s salary deferral money. Since the 20% withholding is only a requirement on distributions that could otherwise be rolled over, it does not apply (usually) to hardship withdrawals. In the case of those rare plans that allow employer funds (match, profit sharing, etc) to be taken out as a hardship withdrawal, the 20% withholding requirement would apply to any withdrawals taken from those funds.

Of course this doesn’t change the fact that it’s all still taxable income and that you’ll get stuck with the excise tax if you’re under 59.5. You can almost always elect out of the withholding though.

http://www.irs.gov/publications/p575/ar02.html#en_US_publink1000226809

Also, the concept that a certain portion of cash must be left in a 401(k) account to provide collateral for a previously taken loan is not correct…at least it’s not an IRS/DOL requirement.
A loan from a 401(k) plan needs to be adequately collateralized at the time it is taken…not at all points in the future. I don’t have a ready cite for that, but would be happy to dig something up if someone wants to pursue the point.

18

Unfortunately, the deposit takes almost five years.

Yes, FIVE YEARS.

The same amount of time this thread had been dead before you revived it.