401(k) Hardship Withdrawal Rules 2022
Siân Killingsworth / 5 May 2022 / 401(k) Resources
The CARES Act of 2020 allowed up to $100,000 in early hardship withdrawal distributions at age 59.5 from 401(k) and IRA retirement savings plans without the usual 10% penalty. However, the IRS discontinued the early pandemic program in 2021, and it is no longer available in 2022. If you are currently experiencing financial hardship, options still exist, but borrowing from your retirement should be treated as a last resort.
When to Make a 401(k) Hardship Withdrawal
A hardship withdrawal may be useful when a bankruptcy filing or foreclosure on your house appears imminent. It can also be better than a high-interest loan. Common reasons to withdraw 401(k) funds early include:
- Medical bills
- Avoiding foreclosure on a primary residence
- Educational expenses
- Funeral expenses
- Natural disaster home repairs
How Early Retirement Plan Withdrawals for Hardship Work
Normally, you’ll need to check with your HR department or plan sponsor to find out if a 401(k) hardship withdrawal is available. Not all plans allow it. If the withdrawal is allowed, you may be asked to demonstrate an “immediate and heavy” financial need and prove that you lack the assets to cover it.
Once approved, you’ll have to add the amount borrowed onto your taxable income for the year and pay a 10% penalty. Usually, the IRS withholds about 20% of an early withdrawal to cover taxes, so if you take out $10,000, you may only receive $7,000 after the tax withholding and penalty.
On top of that, you’ll be losing out on all the gains and compounding interest you would’ve received by keeping your money in the account. Assuming a 9.6% annual return, someone in their thirties borrowing $10,000 from a 401(k) could be losing more than $117,000 in total returns, according to Forbes.
Furthermore, creditors on the lookout for asset recovery could potentially go after any money they see sitting in a checking account. However, they are not permitted to touch money left in a 401(k). For these reasons, early 401(k) withdrawals are generally not recommended.
401(k) Hardship Withdrawal Rules 2022 At-A-Glance:
- % Amount Available: 50% of total balance
- $ Amount Available: $50,000
- Proof of Hardship: Y
- Withdrawal Taxable: Y
- Withdrawal Penalty: Y/N – depends on the circumstances
- Repayment: N
Will I Have to Pay a Penalty for Taking a 401(k) Hardship Withdrawal in 2022?
The 10% penalty for 401k hardship withdrawals is waived in cases of:
- Becoming totally disabled
- Medical debt in excess of 7.5% of adjusted gross income
- Court order to give the money to a former partner in divorce
- Leaving the company for any reason in the year you turn 55 (or later)
- Leaving the company after arranging for a gradual withdrawal over the course of your life expectancy
How Much Can I Borrow With a 401(k) Hardship Withdrawal in 2022?
Plans that allow early distribution in 2022 let you borrow only what is necessary to cover the cost of the stated expense. You can take out up to 50% of your balance or $50,000 under normal circumstances. If you took out a CARES Act loan, you could have taken up to 100% of your balance or $100,000. This maximum includes all tax-advantaged retirement savings funds like IRAs, 403(b)s, and other 401(k)s.
Alternatives to 401(k) Hardship Withdrawal in 2022
The sun has already set on early COVID-related tax relief, though you may consider alternate options like:
- Cutting back on everyday living expenses
- Transferring expenses to a 0% interest credit card
- Tapping emergency savings, tapping a brokerage account, or
- Taking out a 401(k) Loan
How Are 401(k) Loans Different Than 401(k) Hardships?
The main difference between 401(k) hardships and 401(k) loans is your ability to repay. In most cases, the loan amount will be limited to $50,000 (or 50% of your balance), and you’ll need to repay the money within five years at a low interest rate.
If you are age 59.5 or younger and leave your job before paying back the loan, you’ll have until Tax Day of the subsequent year to repay the entire loan. Otherwise, the full balance will be taxed and penalized as a withdrawal. On the other hand, 401(k) hardships do not need to be repaid and are not charged interest.
What Is the Rule of 55?
The “Rule of 55” allows early distribution as early as age 55, penalty-free, so long as you’re retiring from the workforce and not simply changing employers. If you’re 59.5 or older, you can take regular 401(k) distributions without penalty, though they’ll be taxed as income unless you have a Roth 401(k) plan.
How Are My Taxes Different In 2022 If I Took Out a CARES Act Loan in 2020?
Just over 5% of 401(k) plan participants took advantage of the CARES Act of 2020’s special withdrawal rules. These rules redefined hardship for people diagnosed with COVID-19 or whose spouse/dependent had been diagnosed with COVID-19, as well as people with financial issues due to quarantine, furlough, lay-off, lack of access to childcare, or reduced business operations.
These withdrawals had to be made before December 30, 2020. Borrowers were expected to pay regular taxes on the withdrawal in most cases, but the income could be spread out evenly over the 2020, 2021, and 2022 tax years to minimize the impact. So, if you took out one of these early hardship withdrawals, you may need to file an amended tax form this year and next indicating additional income provided by the hardship withdrawal.
Get Your 401(k) Back on Track After a Hardship Withdrawal
Someone between the ages of 30-50 can get a 401(k) back on track after a hardship withdrawal by boosting retirement savings as little as 1% per paycheck. Borrowers between ages 50-70 may need a more aggressive savings plan, depending on how much was borrowed and how soon they want to retire.