Author: Paul A. Carl, CHSA, CPFA^™ Vice President, Retirement Plan Consulting, Registered Representative

[A previous Retirement Meditation (Retirement Meditation #26) addressed in-service withdrawals and touched on Hardship Withdrawals. The Retirement Meditation purposely did not detail hardship withdrawals enabling this week's deeper exploration.]

A family was running short on cash and a college tuition bill was looming for the upcoming semester for their oldest child. The mother, a participant in her company’s 401(k) plan, broached the idea of a hardship withdrawal from her 401(k) account. In speaking with the plan’s investment advisor, ultimately the family paid the tuition through a non-taxable withdrawal of life insurance premiums from the father’s cash value life insurance policy. The result: Tuition paid, no personal income tax effects, and accumulated retirement savings remained intact.

The decision to offer Hardship Withdrawals from a retirement plan rests with the plan sponsor. Hardship withdrawal provisions are an option but not a requirement. Historically, I have found that most plan sponsors are willing to include hardship withdrawal provisions in lieu of offering participant loan provisions. Whether or not there is supporting data on my personal observations I do not know. The first step for any participant seeking a hardship distribution is to determine if their plan offers hardships.

For plans offering hardship withdrawals, plan sponsors may create their own set of rules - complete with extensive policies, processes and procedures, which they excessively document and apply in a completely unbiased manner - or adopt the IRS safe harbor rules. Most plan sponsors adopt the hardship safe harbor rules because they represent a type of fiduciary safety-net by outlining what constitutes a hardship. In effect, the safe harbor reasons for hardship are a gift from the IRS to plan sponsors to help simplify plan administration. 

The six safe harbor reasons for hardship include:

• Expenses related to medical care not otherwise covered or reimbursed by health insurance;
• Costs related to the purchase of a primary residence for the plan participant;
• Payment of tuition and related education expenses of post-secondary education for the participant, spouse, or dependents;
• Payment for funeral and burial expenses for certain individuals related to the participant;
• Payment to avoid eviction from or foreclosure on the Participant’s primary residence; and
• Expenses related to the repair of the participant’s primary residence. 

It’s important to note that, with the exception of the withdrawals from a Roth source or expenses related to medical care that exceed 7.5% of adjusted gross income, each hardship withdrawal subjects the participant to personal income tax. For participants younger than age 59-1/2, a 10% excise tax penalty applies. 

What does this mean? For anyone taking a hardship withdrawal from their retirement account, they will not only be permanently removing funds from their accumulated retirement savings, but they will most likely be paying taxes - maybe excessively - for doing so. 

Do you have other funds available to cover immediate and heavy financial needs?

HORAN Capital Advisors, LLC is an SEC registered investment advisor. The information herein has been obtained from sources believed to be reliable but we cannot assure its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Any reference to past performance is not to be implied or construed as a guarantee of future results. Market conditions can vary widely over time and there is always the potential of losing money when investing in securities. HCA and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only and is not intended to provide and should not be relied on for tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.