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Pros and cons of a 401(k) hardship withdrawal

On Behalf of | Jan 8, 2018 | Chapter 13 Bankruptcy

Some people in Texas who are struggling with debt might be able to use a 401(k) hardship withdrawal. Only certain types of 401(k) plans allow this type of withdrawal, and it can be used only for specific types of expenses. 401(k) hardship withdrawals can be used for funeral or burial expenses, payments that prevent foreclosure or eviction, repairs for some types of home damage, a new primary residence or medical bills.

This type of withdrawal comes with other limits. A person can only take out enough to pay the specific expense. Furthermore, people can only withdraw the amount they have contributed and not returns. An employer must approve a hardship withdrawal, but the IRS will not ask for additional proof. However, eligibility for a 401(k) loan or access to other funds means the employer is supposed to deny the request.

There are still a number of consequences for taking this withdrawal. A person may have to pay taxes on it, and this could significantly reduce the size of the distribution. Furthermore, an employer might be able to prohibit a person from making further withdrawals from the account. Taking the money out reduces the retirement account not just by the amount removed but also by the returns it would have generated.

Unfortunately, a person may not qualify for a hardship withdrawal or have an account at all. Even if someone does qualify, depending on the amount of the debt and how close he or she is to retirement, doing so could leave that individual with little for retirement. The debt may be too high to cover with a hardship withdrawal. In some circumstances, a person might want to look into bankruptcy. By filing for Chapter 13 bankruptcy, an individual may be able to stop a foreclosure and keep his or her home and other assets.