401k vs ira hardship withdrawals
I have a client who worked for a company that recently went belly up. They are in their 40’s, and have almost depleted thier savings over the last several months. He has a 401(K) through the recently failed employer, and wants to know what the guidelines are to qualify for a hardship withdrawal were he to withdraw some of those funds. The documentation on the IRS website seems rather vague to me in their definition of ‘hardship.’ I have two questions:
1. if they were to withdraw money from the 401k to cover their housepayment or other necessities, does that count as hardship, and what documentation would be necessary to justify it.
2. If they rolled the funds over to an IRA, and then took out the same withdrawal later on, are the rules the same, or do IRA’s have differnt ‘hardship’ guidelines that a 401k or other qualified plan.
Thanks for any insight you might be able to lend on the topic.
TH
Permalink Submitted by Alan Spross on Mon, 2011-08-01 22:24
Hardship distributions are plan provisions that allow for distributions while the employee is still employed. They are taxable and subject to penalty.
However, it sounds like he has separated from service and therefore there should be no restrictions for withdrawing the funds or rolling them over to an IRA. But the distributions are still subject to tax and penalty. In his situation, if he does a direct rollover to an IRA and then take distributions from the IRA there are more penalty exceptions available to him. Taking IRA distributions for the following reasons will avoid penalty:
1) Medical insurance premiums (self, spouse or dependents) after he has collected 12 straight weeks of UC benefits; these would include Cobra premiums
2) Unreimbursed medical expenses in excess of 7.5% of his AGI and that would be eligible for the itemized deduction
3) Higher education expenses (self, spouse or children)
4) First home purchase
In summary, he should be able to get the funds distributed, just that they would be taxable (except any after tax contributions in the 401k) and subject to penalty unless he has the specific expenses listed.
He could start substantially equal payments from an IRA but since that must continue until 59.5, this would only be a last resort and would not be wise if he expects to find other employment. This type of plan would only get him around 5% of the value of the rollover IRA (plus any other IRAs) each year, and if that would not be enough in any year he would have to bust the plan and then have to pay the penalty on all the distributions he took under this plan.