A 401k Hardship Distribution | China Venus

Growing numbers of people in these difficult economic times make a 401k hardship distribution; they liquidate their qualified retirement savings. Sometimes they decide to take a portion of their savings to invest in a house or in their education. Other times however, they are forced to use their tax-favored retirement plan as an alternative source of money to pay bills when faced with a job layoff, a medical emergency, or some other unexpected personal situation rather than face extreme choices like declaring personal bankruptcy.

A 401k hardship distribution should be your financial option of last resort.

There are several specific ways the savings you have accumulated in a qualified retirement program like a 401k plan can be withdrawn. One way to liquidate funds is through a draw down of money (called a qualified distribution) when you have reached the plans retirement age like, for example, 59 1/2 years of age. A second way, the temporary borrowing of funds, depends on provisions written into the retirement plan agreement. The last way to draw down money from a qualified retirement plan is to seek what is known as a 401k hardship distribution.

What is a 401k Hardship Distribution?

A 401k hardship distribution has serious consequences and should only be made when few other options are available to resolve your financial situation. The distribution cannot exceed a participants total elective contributions and earnings. Details permitting a 401k hardship like a plan loan must be provided for in the plan documentation. In fact, Congress passed the Pension Protection Act of 2006 regulating the use of a 401k hardship distribution that relate to medical issues, tuition costs, and funeral expenses for the primary beneficiary of a plan account just like that of the account holder.

What are qualifying expenses for a 401k hardship distribution?

Various types of expenses have been categorized as qualified reasons for a 401k hardship distribution including:

medical expenses that exceed 7.5% of the taxpayers adjusted gross income (AGI)
first-time home buyer purchases up to $10,000
qualified higher education expenses
a medically-determinable disability that can interferes with gainful employment, is expected to result in death, or could continue for an indefinite period
expenses that would prevent foreclosure of a principal residence
expenses related to the repair of major damages (casualty) to the principle residence
Is a hardship distribution taxable in the current year?

The distribution of funds from a retirement savings plan like a 401k or traditional IRA is never tax-free; the distribution is taxed along with other income at the marginal tax rate in the tax year the distribution takes place. Qualified distributions typically occur after the age of retirement when theoretically a taxpayer no longer receives regular wages and pays higher marginal income tax rates. Non-qualified distributions such as early or premature distributions typically happen before the plans retirement age; they are subject to both the income tax rate and to a 10% penalty. A 401k hardship distribution does not avoid any additional income taxes owed but, when allowed, is exempt from the 10% penalty.

How do I claim a 401k hardship distribution exemption?

Seek professional tax advice when you receive an IRS Form 1099-R, Distribution From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The Distribution code(s) that appears in Box 7 on the income document describes circumstances that relate to the distribution. An adjacent area can be checked if the plan is IRA, SEP, or SIMPLE. A code 7 in the box indicates a normal or qualified distribution; distribution code 2 signifies an early distribution where exceptions apply such as a Roth IRA conversion, results of an IRS levy, etc. or other circumstances not related to Code 1 early distribution, Code 3 disability, or Code 4 death. Your tax professional interpret these codes and, where appropriate, complete additional tax forms supporting your claim for a 401k hardship distribution exempted from the 10% tax penalty.

401k Hardship Distribution

Source: http://china-venus.com/finance/a-401k-hardship-distribution/

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