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February 23, 2009

Hardship Withdrawal or Hardship Distribution

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Definition

Withdrawal from a participants Retirement Savings account as a result of the participant experiencing  a financial hardship.


Hardship must be defined in the plan document
, but typically fall within “circumstances of sufficient severity that a participant is confronted by present or impending financial ruin or his family is clearly endangered by present or impending want or privation.”.

Hardship distribution can occur from a profit sharing, 401(k) plan, stock bonus plan or a 403(b) plan. Hardship distributions cannot occur from a pension plan.

The hardship distribution rules must be applied to participants on a consistent basis

Under a 401(k) plan, an in-service withdrawal of elective contributions may not be distributed before a triggering event occurs.

A hardship distribution of elective deferrals is limited to “immediate and heavy financial need”, which includes medical care,  preventing eviction from principal residence and  paying tuition expenses for higher education

Referring Cite

IRC § 401(a), Revenue Ruling 71-224, IRC §401(k)(2)(B)(i)(IV); Treas. Reg. §1.401(k)-1(d)(1) , Treas. Reg. §1.401(k)-1(d)(3)

Additional Helpful Information

  • Hardship must be shown by positive evidence submitted to the plan trustee.
  • The plan should include examples of circumstances wherein hardship may be found but at the same time not limit such findings to those listed.
  • Hardship distributions are not rollover eligible, and therefore not subject to the 20% mandatory withholding that applies to eligible rollover distributions which are not processed as a direct rollover. IRC §402(c)(4)(C)
  • Under a 401(k) plan, an in-service withdrawal of elective contributions may not be distributed before a triggering event occurs.
  • 1.401(k)-1(d)(3)(ii): Limit on maximum distributable amount— says the following:
(A) General rule. A distribution on account of hardship must be limited to the maximum distributable amount. The maximum distributable amount is equal to the employee’s total elective contributions as of the date of distribution, reduced by the amount of previous distributions of elective contributions. Thus, the maximum distributable amount does not include earnings, QNECs or QMACs, unless grandfathered under paragraph (d)(3)(ii)(B) of this section.
B) Grandfathered amounts. If the plan so provides, the maximum distributable amount may be increased for amounts credited to the employee’s account as of a date specified in the plan that is no later than December 31, 1988, or if later, the end of the last plan year ending before July 1, 1989 (or in the case of a collectively bargained plan, the earlier of—
(1) The later of January 1, 1989, or the date on which the last of the collective bargaining agreements in effect on March 1, 1986 terminates (determined without regard to any extension thereof after February 28, 1986); or
(2) January 1, 1991 and consisting of—
(i) Income allocable to elective contributions;
(ii) Qualified nonelective contributions and allocable income; and
(iii) Qualified matching contributions and allocable income.
(iii) Immediate and heavy financial need—(A) In general. Whether an employee has an immediate and heavy financial need is to be determined based on all the relevant facts and circumstances. Generally, for example, the need to pay the funeral expenses of a family member would constitute an immediate and heavy financial need. A distribution made to an employee for the purchase of a boat or television would generally not constitute a distribution made on account of an immediate and heavy financial need. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at http://irapublications.com. Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.

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