Because a 401(k) is an employer-sponsored retirement plan, the sponsor gets to define many of the rules governing withdrawals. The Internal Revenue Service does not require employers to allow hardship distributions. The specific guidelines on whether you can take such a withdrawal from your 401(k) are in your plan's rules.
The IRS allows penalty-free hardship withdrawals from a 401(k) if you have an immediate, heavy financial need. However, the agency defers to the plan sponsor to decide what distributions, if any, qualify. These may include withdrawals to pay certain medical insurance premiums or medical bills exceeding 7.5 percent of your income for the year, make court-ordered child-care or alimony payments, or cover you if you become completely disabled. Most 401(k) distributions are taxed as income even if a penalty does not apply.
Other Early Distributions
Generally, the IRS will charge you a 10 percent penalty for any distribution you take from a 401(k) before age 59 1/2. However, if you have already separated from your employer, you can begin taking penalty-free withdrawals as early as the year in which you turn age 55.
Some 401(k) plans do not allow in-service withdrawals, whether or not you have a hardship. In some cases, you must leave the company before you can take a distribution.
There is no penalty on rolling a 401(k) balance over to an IRA if your plan allows this. IRAs have clearly defined exceptions to early withdrawal penalties. If your plan allows in-service distributions or you no longer work for the company, this is a possible course of action. Some 401(k) plans also allow you to borrow funds penalty-free, rather than take a distribution. You don't have to declare the loan amount as income or pay a penalty if you pay your 401(k) back, with interest, in five years.
Leslie McClintock has been writing professionally since 2001. She has been published in "Wealth and Retirement Planner," "Senior Market Advisor," "The Annuity Selling Guide," and many other outlets. A licensed life and health insurance agent, McClintock holds a B.A. from the University of Southern California.