401(k) Hardship Withdrawals
When you take a withdrawal, you're going to face a 10% penalty if you're under the age of 59.5, but there are certain stipulations that allow you to take this money to wave this 10% penalty which are known as hardship distributions.
The first thing that you need to do is check with your HR administrator or your plan administrator to understand if they allow for hardships. If you have the green light then there are many ways to qualify:
Some of the reasons that you qualify for a 401(k) hardship distribution are unreimbursed medical expenses, purchase of a principal residence or college tuition which includes room-and-board for you or a dependent, payments to prevent eviction or foreclosure, funeral expenses or even certain expenses to pay for repairs on your home.
Special Circumstances with COVID
If you have a COVID related situation, there is a chance that you could get the penalty fee waived under the CARES Act.
401(k) Withdrawal Example
Say that you take out $20,000 and it was a withdrawal that does not qualify as a hardship. That means a 10% penalty will automatically be taken right off of the top which is $2,000 hit.
Second is the penalty based on your tax bracket which means that you will be taxed at your normal income tax rate when filing with Uncle Sam. This is one form of double taxation.
For example, if your federal tax is at 20% that would be an additional $4,000.
So in total this is a $6,000 penalty and you can't get this money back. This differs from a 401(k) loan where the money is paid back with interest. This is also means that you will be taking away from your retirement. In this example, $20,000 is borrowed and only $14,000 is retained,
Everyone's financial situation is unique so there are hardship situations that actually can't be avoided; however, if there's no other option then you have to actually provide proof that you've exhausted all other opportunities to take take that money.
Hence, it is very important to make sure that you don't take the money unless you really need it.