How and When a Hardship Withdrawal is Allowed in an IRA or 401K

First off, what is a hardship withdrawal? A hardship withdrawal is defined as an emergency withdrawal of retirement funds from a retirement plan. This type of distribution can be allowed without penalty from retirement savings vehicles like Traditional IRAs or 401Ks, given that specific requirements are met. It’s important to note that even if all criteria are met on behalf of the plan’s owner, they still might incur standard income taxes.

Medical

Within the IRA rules, there’s an IRS-mandated condition that a 10% penalty will be taken from the distributed funds if taken before age 59½. Suppose the IRA holder does not have health insurance or has medical expenses that are more than their insurance will cover for the year. In that case, they might be allowed to take penalty-free distributions from their IRA to cover these expenses. Note that only the cost difference between these expenses and 7.5% of the IRA owner’s adjusted gross income (AGI) is considered eligible.

Unemployment

If the IRA owner is unemployed, they’re permitted to take penalty-free distributions to pay for medical insurance. To qualify for this benefit, they must have involuntarily lost their employment. The IRA holder must have received the distributions that same year or the year after receiving unemployment compensation and no later than 60 days after you get another job. And the bills must be significant—representing at least 10% of their AGI—and not covered by any health insurance.

Disability or Higher Education

The Internal Revenue Service allows for early, penalty-free withdrawals from IRAs for other reasons that may or may not be prompted by hardship. These include having a mental or physical disability or needing funds to pay higher-education bills for the owner, spouse, children, or grandchildren.

Hardship Withdrawals from 401K

Whether or not one is indeed eligible for an early distribution (hardship or whatever reason) is entirely up to the 401K plans’ sponsor, either through employment or self-employment. The IRS states that “A retirement plan may, but is not required to, provide for hardship distributions,” It is solely up to the provider to specify the criteria that define a hardship. They may ask for information and documentation of said hardship.

If 401K plan withdrawals are permitted, the IRS governs whether or not the 10% penalty for withdrawals made before age 59½ will be waived, as well as how much is allowed for withdrawal.

Medical insurance premiums cannot be made through 401K funds as they can with IRA funds. Withdrawals to pay for education or expenses for purchasing a first home (free of penalties) are not permitted within a 401K but are both allowed at a penalty-free rate for IRAs.