Does Unemployment Count as 401k Hardship Withdrawal?

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Point of Interest

If you need cash and want to borrow it from your 401(k), you should know that withdrawals are possible if you meet the eligibility criteria, your plan provider allows it and you follow the necessary steps to complete the process.

When times are tough, you may find yourself in need of some quick cash to cover necessary expenses. Due to the effects of COVID-19, more than 40 million people had filed for unemployment as of the last week of May, meaning that right now there are a lot of people in dire need of temporary cash flow. If you’re in a similar situation, the best way to navigate these uncertain waters is to know your options.

One option that may be available to you if you’re in need of quick cash is a 401(k) hardship withdrawal. The IRS has certain conditions that may give you the ability to tap into your 401(k) retirement account early, without incurring early withdrawal penalties.

What qualifies as a hardship?

According to the IRS, a “safe harbor” in IRS regulations allows employees to withdraw money from their 401(k) for “heavy and immediate” financial needs. The hardship has to meet two conditions to qualify: 1.) it is both an immediate and heavy financial need, and 2.) the amount you withdraw is limited to the amount necessary to satisfy the financial need.

Under the safe harbor, an employee is automatically considered to have an immediate and heavy financial need if the distribution is for any of these:

  • Medical care expenses for the employee, the employee’s spouse, dependents or beneficiary
  • Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments)
  • Tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents or beneficiary
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence
  • Funeral expenses for the employee, the employee’s spouse, children, dependents, or beneficiary
  • Certain expenses to repair damage to the employee’s principal residence

Unemployment isn’t a hardship specifically, but the ramifications of having limited or no income, such as medical bills you can’t pay or home payments you can’t make, are qualifications. So, in a roundabout way, being unemployed could lead to situations where you can withdraw 401(k) funds under the safe harbor.

It’s important to keep in mind, though, that a hardship withdrawal must be approved by the plan provider. The IRS has put out guidance to plan providers in response to the current economic climate, which can shed more light on the likelihood of your hardship withdrawal being approved.

Even if you are approved for a 401(k) or IRA hardship withdrawal, you may be required to pay income taxes on the withdrawal as well as a 10% additional tax penalty. If your 401(k) is a Roth, you won’t need to pay income taxes because you paid them when you invested the money. If you have a traditional 401(k), though, you will be responsible for income taxes.

When it comes to the additional 10% tax penalty for early withdrawal, the IRS lays out the specific situations when you will and will not have to pay this. For example, anyone who loses their job or quits between the ages of 55 and 59 ½ is eligible to withdraw their funds without an additional penalty. For many public safety and government employees, the age limit drops to 50.

How to make a 401(k) hardship withdrawal

1. Determine the exact amount you need to satisfy your hardship withdrawal needs.

One of the key elements of eligibility for a hardship 401(k) withdrawal is that you only take out enough money to satisfy the need. You’re not able to just take money as you please. Determine the exact dollar amount you are going to need — which should be specific to your hardship claim.

2. Prepare a statement of verification of your need.

Your plan provider will most likely require a letter of verification to prove you are experiencing the need you claim. Depending on your plan provider, you may be required to provide some additional documentation. For others, a simple signed letter stating your needs may be sufficient.

3. Review your 401(k) plan and contact your plan provider.

In order to get your 401(k) hardship withdrawal, you will need to get approval from your provider. Some plans won’t allow the withdrawals and some plans limit which needs they will accept requests for. Review your plan and contact your provider to make sure your needs qualify.

4. Complete the requested paperwork.

Once you’ve completed the first three steps, you’ll need to complete the paperwork to request the withdrawal. This paperwork will come directly from your plan provider.

Alternatives to 401(k) hardship withdrawal

File for unemployment

If you’ve lost your job, you may be able to file for unemployment. Prior to the events of COVID-19, the restrictions on unemployment claims were long and required specific circumstances for approval. However, many state governments have greatly relaxed those requirements over the last few months to allow more people to access unemployment funds in the wake of recent events. Ideally, you should look into unemployment before considering a 401(k) hardship withdrawal.

Apply for a personal loan

Another option that you may want to consider if you’re in need of quick cash is a personal loan. Personal loans can give you access to upward of $100,000 with some providers — without the need for collateral. You will be required to pay this money back, and there is a cost to borrowing. You will also need to have decent credit to get help from most lenders. There are some lenders willing to work with people with subpar credit, but the cost of borrowing will be higher.

Home equity line of credit (HELOC)

If you are a homeowner who has equity in your home, you may be able to get a home equity line of credit (HELOC). This type of loan allows you to tap into your home’s equity without the need to sell. For many, this can mean fast cash without an in-depth approval process. Be aware, though, that your house is collateral for this type of loan. This means that you may lose your home if you default on the loan. Banks will look at your credit score, debt-to-income ratio and overall creditworthiness when determining approval.

Credit card

A credit card might be a viable option for people who have smaller expenses to cover. Credit cards give you a revolving line of credit that can be used and reused over and over again without a new application. If you carry a balance for over a month, though, you will pay interest on the money you are borrowing. However, many credit card companies have introductory offers that allow you to forego any interest charges for a period of time as a welcome bonus. Generally, these periods are a few months to a year or more.

The final word

The first step to navigating uncertain times is knowing what your options are. A 401(k) hardship withdrawal may be the right choice to help you out when you need access to money before your scheduled retirement date. If you’ve exhausted other options, contact your plan provider and see what your eligible options are.

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