The high cost of 401(k) hardship withdrawals

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By James J. Thompson | 23 March 2012

As we enter another presidential election year, one of the biggest issues that Americans worry about is the state of the U.S. economy. Who can blame them? Over the past five years Americans have endured the “Great Recession” and saw the unemployment rate jump from 4.6% in 2007 to 9.6% in 20101, rates not seen since the early 1980s. During this period many retirement plan participants found themselves struggling to make ends meet. Many who remained employed turned to their retirement plans and took out hardship withdrawals to help ease their financial burdens. Some participants requested these withdrawals because it was their last resort, while others took them without fully understanding the short-term and long-term consequences. This trend continues today, which is why it is important for both those working with participants, as well as participants themselves, to be fully aware of what is at stake when hardship withdrawals are considered.

What is a hardship?

A hardship is a withdrawal option within a defined contribution (DC) plan that allows actively employed participants to pull funds out of their retirement account under specific circumstances that are due to heavy financial burdens. There are strict requirements that must be met to qualify and receive this type of withdrawal, which will be outlined in more detail later. It is also important to note that a hardship withdrawal is not required to be available in all retirement plans, but is instead allowed if the plan sponsor chooses to adopt it as a withdrawal option.

Hardships are allowed within 401(k), 403(b), and 457(b) retirement plans as well as some individual retirement accounts (IRAs).2 The rules governing these withdrawals vary depending on the type of retirement plan the hardship is being taken from. The remainder of this article will be talking in terms of 401(k) retirement plans.

Hardship requirements

There are two main requirements that need to be satisfied to qualify as a hardship. The first is that the hardship withdrawal must be due to an immediate and heavy financial need. The IRS uses the examples of buying a boat or a television as situations that would not qualify under this condition.3 The second requirement is that the amount distributed under the hardship be restricted to the necessary funds needed to satisfy the financial need.4 This means that a participant can’t receive a hardship withdrawal in the amount of $10,000 when only $2,000 is needed.

The amount available for distribution is generally restricted to the amount the participant has contributed to the plan (without earnings). Some plans do allow employer contributions to be available as well, but this is not as common. In addition, the hardship withdrawal is not rollover-eligible, meaning that the funds distributed cannot be placed in an IRA or another qualified retirement plan to keep its tax deferred status.

What qualifies as a hardship?

The determination of what qualifies as a hardship is usually, but not always, based on “safe harbor” standards. These standards are outlined by the IRS to help plan sponsors determine if a participant’s situation qualifies as a hardship event. The eligible hardship events under the safe harbors are:

  • Medical care expenses that have been incurred or for medical care that is needed
  • Costs associated with purchasing a principal residence (excluding mortgage payments)
  • Tuition payments, educational expenses, or room and board expenses that will be incurred during the next 12 months of postsecondary education
  • Payments to prevent either eviction or foreclosure on a principle residence
  • Funeral expenses
  • Certain expenses related to repairs of a principal residence that are due to damage

Prior to the Pension Protection Act of 2006 (PPA), the hardship events of medical, educational, and funeral expenses were allowed to cover the employee, spouse of the employee, and children or dependents of the employee. Once the PPA was passed these three hardship events were expanded to allow coverage to primary beneficiaries. A primary beneficiary is considered someone named under the plan as a beneficiary who has a right to all or a portion of the participant’s account if the participant passes away.5

Applying for a hardship

To be eligible to take a hardship withdrawal you must not have any other options available to you to satisfy the need. This can be hard to determine but some examples of “other options” include:

  • Stopping elective deferrals
  • Receiving any available loans
  • Receiving compensation through insurance proceeds
  • Selling assets in which the participant has an interest6

If these cannot satisfy the hardship need then a hardship may be available. Approval for the hardship requires the participant to provide supporting documentation that verifies the amount requested. If the supporting documentation does not add up to the amount requested then most likely the participant would either be asked to provide further documentation or would only be approved for the amount supported by the documentation. It is important to know that the amount requested is allowed to be increased by the estimated taxes and penalties that may be incurred by taking the hardship withdrawal.7

What does taking a hardship mean to a participant?

The benefit of taking a hardship withdrawal is pretty straightforward; participants are allowed to pull money out of their retirement plan to cover the financial hardship event. Assuming the necessary forms and documentation are provided when the hardship is requested, the time frame for processing can be relatively short.

On the other hand, the consequences that come from taking a hardship withdrawal are numerous, especially for participants under the age of 59½. The first consequence, regardless of your age, is the fact that participants are required to be suspended from making participant elective deferrals for at least six months after they receive the withdrawal. This means that during the suspension period no new contributions are being deferred from the participant’s paycheck on either a pretax or Roth after-tax basis. If the employer does any sort of matching contribution, the participant would also lose out on these contributions during the suspension period.

Another significant consequence that participants will need to deal with if they take a hardship withdrawal is the tax liability. Because a hardship is different from a plan loan, and is not paid back over time, it is considered a distribution from the plan. This means that the necessary taxes need to be paid on the amount distributed. The tax rate will be based on the tax bracket that the participant falls into when they do their year-end taxes. If the participant is under the age of 59½, they will also be required to pay a 10% early withdrawal penalty on top of any taxes they owe on the withdrawal. When the administrator processes the withdrawal, typically 10% of the gross amount is withheld for federal tax withholding. If the tax amount withheld when the withdrawal was processed does not cover the tax liability for taking the hardship, the excess will be made up when the participant files their taxes for the year in which the distribution occurred. This is usually where participants realize the financial impact they are taking. In addition, some plans may charge a fee to take a hardship withdrawal.

There are certain exceptions to the 10% early withdrawal penalty, which are found in section 72(t) of the Internal Revenue Code and affect any early withdrawal, not just hardships. To review these exceptions, please view the early distribution exception chart provided by the IRS.

The example below illustrates the fee, tax, and penalty ramifications for taking a hardship withdrawal.

  • Mike has tuition payments that he will be incurring during the next 12 months.
  • He wants to take out enough to receive $10,000 to pay for his tuition.
  • Mike is in the 25% tax bracket and under the age of 59½, and does not qualify for any 72(t) exemptions.
  • There is a $100 fee to take a hardship withdrawal from his employer’s 401(k) plan, as shown in Figure 1.
Fees and taxes for hardship withdrawals

As you can see, Mike had to pull $15,484.62 out of his retirement account to be able to receive the $10,000 he needed to pay his tuition, effectively giving away over a third of the full amount. Combine this with the fact that he now has been suspended from making any elective deferral contributions for six months, which may also mean no matching contributions from his employer. These are big consequences that will have a lasting effect on Mike’s retirement account for years to come.

Time value of money

One of the biggest consequences of taking a hardship withdrawal is something that participants rarely consider: the lost opportunity of compounding interest earned over time. By applying the time value of money theory, the idea that a dollar today is worth more than a dollar in the future because of its potential earning power,8 participants could be missing out on thousands of dollars at retirement.

Continuing with the earlier example of Mike taking a hardship withdrawal in the gross amount of $15,484.62, and combining the lost contributions that would have been contributed over the suspension period, it is eye-opening to see the amount that could be missed at retirement because of a hardship withdrawal being taken. Below is an illustration of this.


  • Gross amount taken because of hardship was $15,484.62.
  • Total elective deferrals and employer matching contributions equal $2,700 for a six-month period.
  • An assumed 7% rate of return annually.
  • Mike is 30 years of age and will work for 35 more years before retiring at age 65.
Financial impact of hardship withdrawals

Figure 2 shows how Mike could be missing out on approximately $194,000 when he retires because he took a hardship withdrawal at the age of 30. The lost compounding interest on the $18,184.62 that will no longer be in his account will greatly affect his retirement savings.

The financial consequences for taking a hardship withdrawal add up and greatly affect the participant’s ability to meet retirement saving goals. The alarming fact is that many participants are taking more than one hardship withdrawal out of their retirement plans. When multiple hardship withdrawals are taken, the negative effects compound, creating bigger obstacles for participants to tackle before they reach retirement.

As with anything, there are always two sides to a story. Some may argue that if you are in a bad financial situation and don’t take a hardship withdrawal to help alleviate the circumstance, you may be worse off. There are obviously certain situations where this could be the case, but participants need to understand that a hardship withdrawal should be their last resort. Participants should also be encouraged to consult with their tax and financial advisors prior to making any hardship request. The more a participant can be educated and informed of the possible financial consequences their hardship withdrawal could cause, the more prepared they will be for retirement, whether that day is in a few months or years down the road.


1U.S. Bureau of Labor Statistics (February 3, 2012). Labor Force Statistics from the Current Population Survey. U.S. Department of Labor. Retrieved February 25, 2012, from

2Internal Revenue Service (September 14, 2011). Retirement Plans FAQs Regarding Hardship Distributions. Retrieved February 20, 2012, from,,id=162416,00.html#1.

3Internal Revenue Service (January 13, 2012). Retirement Topics - Hardship Distributions. Retrieved February 20, 2012, from,,id=211439,00.html.

4Internal Revenue Service (January 23, 2012). 401(k) Resource Guide - Plan Sponsors - General Distribution Rules. Retrieved February 22, 2012, from,,id=151926,00.html.

5Sungard (January 1, 2007). IRS Issues Additional PPA Guidance. Retrieved March 2, 2012, from

6401(k) Resource Guide, ibid.

7401(k) Resource Guide, ibid.

8Investopedia. Time Value of Money - TVM. Retrieved February 28, 2012, from