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No Penalty IRA/401k Hardship Withdrawls

30 May 2009 69,766 views One Comment
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ira_10percentSo you’ve lost your job and you’re behind on the mortgage. About to lose your house? No savings left. No credit cards to borrow. Under 59 1/2? How about tapping that 401k or IRA? Well, up to now you’re permitted to, just so long as you pass along 10% to Obama and the Feds in addition to being taxed at your normal federal income bracket.

C’mon folks, it’s time to remove the 10% penalty and let people access what’s rightly their money without the penalty. It’s time to get rid of the 10% penalty for hardship situations AND allow loans on IRA’s

Limited Options

Basically, this article is for those under age 60 because if you’re over 60, go have at your money, penalty free!

But if you’re under 59 1/2 (who came up with that anyway), you’ve got a few options, but lots of them steal 10% as a penalty for early withdrawal.

Yes there is the ability to take out a 401k loan which is a good idea if you have to.  It’s fairly simple and you’re basically borrowing money from yourself tax free. But there’s a hitch. You have to begin paying the loan back immediately. So make sure you’re borrowing enough to begin paying it back. Default on a payment, and your administrator has the ability to call the loan in it’s entirety, or call it a pre-retirement distribution, and you’ll get the penalty and the tax.

Here are some of the options you’ve got.


If these conditions are met, the funds can be withdrawn and used for one of the following five purposes:

  1. A primary home purchase
  2. Higher education tuition, room and board and fees for the next twelve months for you, your spouse, your dependents or children (even if they are no longer dependent upon you)
  3. To prevent eviction from your home or foreclosure on your primary residence
  4. Severe financial hardship
  5. Tax-deductible medical expenses that are not reimbursed for you, your spouse or your dependents

All 401k hardship withdrawals are subject to taxes and the ten-percent penalty. This means that a $10,000 withdrawal can result in not only significantly less cash in your pocket (possibly as little as $6,500 or $7,500), but causes you to forgo forever the tax-deferred growth that could have been generated by those assets. 401k hardship withdrawal proceeds cannot be returned to the account once the disbursement has been made.

Here’s what the IRS says about hardship withdrawals

Whether a need is immediate and heavy depends on the facts and circumstances. Certain expenses are deemed to be immediate and heavy, including: (1) certain medical expenses; (2) costs relating to the purchase of a principal residence; (3) tuition and related educational fees and expenses; (4) payments necessary to prevent eviction from, or foreclosure on, a principal residence; (5) burial or funeral expenses; and (6) certain expenses for the repair of damage to the employee’s principal residence. Expenses for the purchase of a boat or television would generally not qualify for a hardship distribution. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee. (Reg. §1.401(k)-1(d)(3)(iii))

401k Loan Limits

In most cases, an employee can borrow up to fifty-percent of their vested account balance up to a maximum of $50,000. If the employee has taken out a 401k loan in the previous twelve months, they will only be able to borrow fifty-percent of their vested account balance up to $50,000, less the outstanding balance on the previous loan. The 401k loan must be paid back over the subsequent five years with the exception of home purchases, which are eligible for a longer time horizon.

If you roll over a 401k to an IRA, IRAs (including SEP-IRAs) do not permit loans. Therefore, repaying a loan balance from one plan by transferring the loan balance and making loan payments to an IRA is not allowed. If this transaction was attempted, the loan would be treated as a distribution at the time of the attempted rollover.


Don’t Roll over the 401k to an IRA just yet

IRA’s are much more restrictive vs. a 401K. 401K’s allow loans, and do permit much more hardship situations to access your money if you’re in a tough situation. Most people decide to rollover to an IRA because there are normally limitless investment options (brokerage, ETF’s, Mutual Funds, etc). So just make sure before you call your 401k plan administrator, be sure you’re not interested in a loan, or considering a no penalty hardship withdrawl.

Make sure you study up before rolling over a 401k from your former employer to an IRA. IRA’s are much more restrictive on what you can do. Make sure you do your research before contacting your plan administrator. The 401k admins aren’t tax professionals and don’t always have the right answers (as I’ve found).

IRA’s

IRA’s are even more difficult to access then 401k’s. Oh, IRA’s don’t have loan options either, so you can’t get that great deal of borrowing against up to 50% of your balance and paying the interest back to yourself. That’s another beef that you should be writing someone about. Why the heck not? Withdrawals made prior to age 59 1/2 will probably be subject to the 10% additional penalty tax (in addition to normal federal and state income taxes.

But IRA’s do have a lifetime withdrawal exemption of $10,000 for a house with no strings attached.

Take a look at Form 5329Additional Taxes on Qualified Plans, including IRA’s.

IRA Hardships

There are several exceptions to the rule that penalties apply to distributions before age 59½. Each exception has detailed rules that must be followed to be exempt from penalties. The exceptions include:[2]

  • The portion of unreimbursed medical expenses that are more than 7.5% of adjusted gross income.
  • Distributions that are not more than the cost of medical insurance while unemployed
  • Disability (defined as not being able to engage in any substantial gainful activity)
  • Amounts distributed to beneficiaries of a deceased IRA owner.
  • Distributions in the form of an annuity, see Substantially equal periodic payments
  • Distributions that are not more than the qualified higher education expenses of the owner or their children or grandchildren
  • Distributions to buy, build, or rebuild a first home. ($10,000 lifetime maximum)
  • Distribution due to an IRS levy of the plan.

Where’s the one that says “Hey I lost my job and have depleted all my savings, and don’t want to loose my house exemption”? Hope you don’t have to as Barney Frank or Chris Dodd!

Internal Revenue Service

The fist in the glove only administrates the policies enacted by congress. So if after you’ve checked out the IRS website, and you’ve consulted with a tax or retirement advisor, and you’re still not satisfied with the options, then it’s time to call your congressman.

Check the IRS website for details – Click Here


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One Comment »

  • Vote -1 Vote +1Dave S (author)
    said:

    UPDATE –
    Penalty Hardship Withdrawal – Free IRA withdrawal to pay IRS –

    If Uncle Sam comes after your IRA for unpaid taxes, or in other words, places a levy against the account, you can take a penalty-free withdrawal.

    You also can’t make any contributions to your IRA for six months after a hardship withdrawal. Although the penalty tax is waived, hardship withdrawals must be reported as ordinary income on your income tax return.
    Early Distributions

    You must include early distributions of taxable amounts from your traditional IRA in your gross income. Early distributions are also subject to an additional 10% tax, as discussed later.
    Early distributions defined. Early distributions generally are amounts distributed from your traditional IRA account or annuity before you are age 59½, or amounts you receive when you cash in retirement bonds before you are age 59½.

    Age 59½ Rule

    Generally, if you are under age 59½, you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59½ are called early distributions.
    The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.

    A number of exceptions to this rule are discussed later under Exceptions. Also see Contributions Returned Before Due Date of Return , earlier.
    For a list of eligible early withdrawals without the 10% penalty visit:
    http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230896
    Exceptions
    There are several exceptions to the age 59½ rule. Even if you receive a distribution before you are age 59½, you may not have to pay the 10% additional tax if you are in one of the following situations.
    • You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
    • The distributions are not more than the cost of your medical insurance.
    • You are disabled.
    • You are the beneficiary of a deceased IRA owner.
    • You are receiving distributions in the form of an annuity.
    • The distributions are not more than your qualified higher education expenses.
    • You use the distributions to buy, build, or rebuild a first home.
    • The distribution is due to an IRS levy of the qualified plan.
    • The distribution is a qualified reservist distribution.

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