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Hardship distributions.

Plan sponsors have the option to allow participants to access their accounts while still employed via a  plan loan or an in-service distribution . However, some companies prefer to limit that access so that accounts remain in the retirement plan to be used as intended—at retirement. A hardship distribution can be a compromise between the two, allowing participants access to their accounts only in times of financial hardship.

What is a hardship withdrawal?

The hardship withdrawal provision is an optional feature that can be included in a retirement plan to allow participants to access all or a portion of their account to satisfy an “immediate and heavy financial need.” There are several criteria that are used to determine whether the financial hardship is sufficient to qualify for a withdrawal using this feature.

You said it is an optional provision. Does that mean we can allow hardship withdrawals “on the fly”?

No. In order for a plan to grant hardship distributions, the plan document must specifically include the feature and spell out the parameters that apply.

What types of situations qualify for a hardship distribution?

The regulations have two different standards that can be applied – the safe harbor standard and the non-safe-harbor standard. Due to the extremely subjective nature of the words "financial hardship" many plans apply the safe harbor standard since it spells out the situations that qualify.

There are six of them. They are payment of …

• Expenses for a medical care that is tax-deductible (under Tax Code section 213(d)) to the individual and is not reimbursable by insurance.

Usually medical expenses must exceed a certain percentage of a person’s income before they are deductible; however, that percentage requirement is ignored for this purpose. Also, medical expenses incurred by a participant’s spouse and dependents qualify as a financial hardship.

It is important to note that if the expense is subject to reimbursement by an insurance company at a later date, it does not qualify as a hardship even if the participant is required to make payment up front and await reimbursement.

• Costs related to the purchase of a principal residence.

This must be the participant’s primary home; it cannot be a vacation home. The hardship withdrawal is not restricted to the purchase price and can include other items that are directly tied to the transaction such as closing costs. In addition, if a participant will immediately build a house, a hardship withdrawal can be taken for the purchase of the land on which the house will be built.

• Expenses for up to 12 months of post-secondary education.

This includes tuition, related educational fees, and room and board for the participant, spouse, and/or other dependent.

• Amounts necessary to prevent eviction or foreclosure from a principal residence.

Generally speaking, the participant must have received notice of a pending eviction or foreclosure in order to qualify under this criterion. Simply being a week behind on rent or wanting to avoid a late payment fee from the mortgage company is not sufficient.

• Burial or funeral expenses for the participant’s deceased parents, spouse, children, and/or dependents.
• Expenses for the repair of damage to the participant’s principal residence that are tax-deductible to the participant (under Tax Code section 165) as a casualty loss.

These expenses are similar to medical expenses in a couple of ways. One is the income percentage for tax-deductibility is ignored, and the other is that expenses subject to reimbursement by insurance do not qualify.

It is also important to note that the expenses must be due to casualty loss. For example, if a participant must replace his or her roof because a tree fell on it during a storm, that is a casualty loss and would potentially qualify. On the other hand, if the roof has to be replaced simply because it’s old and worn out, that would not qualify.

• Expenses incurred due to a federally-declared disaster.

The IRS did clarify that the intent is to make expenses related to certain disasters (e.g. hurricanes, floods, wildfires, etc.) safe harbor items, thereby eliminating any delays waiting for the official announcement declaring the emergency – which we all know is not as quick a process as we might prefer. Again, the common theme throughout the regulations is easy access to retirement funds in a time of true financial need. One point worth noting, however, is that unlike previous disaster relief, these new regulations do not allow hardship distributions as a result of a participant’s relatives or dependents incurring disaster-related expenses.  It is now limited only those expenses incurred by a participant who either lives or works in the disaster area.

A plan can, but is not required to, expand the definition of hardship to include any of the above situations that are incurred by a participant’s designated primary beneficiary .

Now that we have covered the reasons, how is the amount determined?

The maximum amount of the hardship distribution is basically the actual amount of the applicable expense minus whatever amounts a participant can access from sources outside the plan. That means a participant is generally required to first exhaust any savings accounts, outside investment accounts, credit card cash advances, loans, etc. that are available to him or her. However, this does not include taking a loan from the retirement plan   to the extent loans are permitted. Any qualified expenses that remain are eligible for hardship.

Obviously, a participant cannot withdraw more than he or she has available in the plan. We will touch on that in a little more detail later in this FAQ.

What happens if using up all of those other resources only makes the financial hardship worse?

There is an exception for this type of situation, but it should be applied with caution. One of the most clear-cut examples where this would come into play is with the purchase of a primary residence. Draining all savings and maxing out cash advances from credit cards would likely cause the mortgage company to reconsider. As a result, the participant would only be required to use other resources to the extent it would not jeopardize his or her ability to obtain the mortgage.

If using other resources is just inconvenient or carries a fee, that is not enough to get out of it.

Are hardship distributions subject to individual income tax?

Yes, the participant must claim the hardship distribution amount as income on his or her individual tax return. In addition, the amount of the withdrawal is subject to an early withdrawal penalty equal to 10% if the participant is under the age of 59 ½.

Hardship withdrawals are not eligible to be rolled over to an IRA or other plan, so they are subject to a voluntary tax withholding at the time of distribution. The default withholding rate is 10%, but the participant can elect to increase or decrease it, or waive it altogether.

It seems like the tax ramifications might add to the hardship. Can a participant increase the amount of the distribution to cover the expected tax burden?

Yes, any reasonably anticipated federal, state, or local tax that will be payable by the participant as a result of the hardship withdrawal can be added to the amount request. In addition, the participant can add any distribution fees that might be charged by the plan’s recordkeeper keeper or other service provider for processing the request.

Who verifies all of this? I don’t really want to get involved in all of those personal details for my participants.

There are two elements of a hardship distribution – the reason and the amount. Plan sponsors do have an obligation to obtain documentation that supports the reason for the request. More on that later.

As for the amount, there are also two elements to be considered. One is the “principal” amount of the request and the other is the ancillary stuff (taxes, fees, other resources, etc.). Plan sponsors should obtain some basic documentation that supports the principal amount requested; however, they can rely on statements from the participant on the amount needed to gross-up for taxes and fees as well as the availability (or lack, thereof) of outside resources.

In other words, sponsors do not have to undertake a financial investigation of the participant. There is one important exception. If the sponsor knows (or reasonably should know) that a participant is being less than completely truthful about his or her financial situation, the sponsor cannot turn a blind eye and should request more documentation. An example of this might be a request to cover medical expenses that the sponsor knows are covered by the company-provided medical plan.

What sort of documentation is required to substantiate the reason and principal amount?

Back in 2015, the IRS provided informal guidance indicating that plan sponsors are required to obtain and keep the following items to document hardship distributions:

• Documentation of the hardship request, review, and approval.
• Financial information and documentation that substantiates the employee’s immediate and heavy financial need.
• Documentation to support that the hardship distribution was properly made according to applicable plan provisions and the Internal Revenue Code.
• Proof of the actual distribution made and related Forms 1099-R.

That guidance indicated that either paper or electronic format is acceptable but that it is not enough for participants to self-certify.

Then , in October 2019, the IRS clarified its audit process for hardship distributions with the introduction of the Summary Substantiation Method. In order for a plan sponsor to satisfy the requirements, participants must self-certify their immediate and heavy financial need through the consistent and proper completion of the IRS self certification form.

Per this process, an IRS agent - and not the plan sponsor - will request any additional information and/or documentation needed in the event the self certification is incomplete or the participant has received more than two hardships during the same plan year (without adequate explanation). 

You can download a sample self-certification form here .

Are there any limits on which plan accounts are available for hardship distribution?

The IRS issued new regulations in 2019 that eliminated most of the restrictions that were previously in place.  That means that all money sources are generally available for hardship distributions; however, each plan sponsor can further restrict availability ion its plan document as it deems appropriate.

There is one key exception.  Any investment gains on 403(b) deferrals are not available – the deferral basis (the amount actually contributed) is available, just not any investment gains on those amounts.  This rule used to apply to 401(k) plans also but was eliminated by the 2019 regulations, so it appears that the continued application to 403(b) plans is more of an oversight than anything intentional.

Other than that, a plan can permit hardship withdrawals from any contribution source in the plan, but it is not uncommon for sponsors to limit hardships only to deferral accounts and/or other accounts in which the participant is fully vested.

Can a participant keep making/receiving plan contributions after taking a hardship withdrawal?

Yes.  Previous rules required participants to suspend their contributions for six months following a hardship withdrawal, but that requirement was eliminated by the 2019 regulations.

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What Documents Are Needed to Support an Educational Hardship Withdrawal?

You can tap your IRA without penalty for qualifying education expenses.

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More Articles

•   1. Can I Withdraw Funds From My IRA for Educational Expenses?
•   2. IRA Distribution: Can I Give to a Child While I am Alive?
•   3. Deductions From Federal Income Tax for Children Attending College

College expenses, including tuition and room and board, averaged $13,600 a year for an undergraduate degree at a public university in 2012, according to the National Center for Education Statistics. These costs increased to $36,300 at a private, not-for-profit university. You can look to your individual retirement account to help fund these expenses, without tax penalties for early withdrawals. You must document your expenses with receipts, and by declaring your withdrawals on your tax forms.

Proof of Expenses

While you do not have to pay the education expenses directly with money from your IRA, you must keep a record of any qualified education expenses. This includes tuition statements from the college, which show the name of the qualified person you are paying expenses for. In addition, if the student is enrolled at least half-time, room and board expenses are qualifying education expenses. Save any statements showing room and board with the college, as well as rent receipts if the student lives off campus.

You will receive an IRS Form 1099-R from your IRA trustee detailing any withdrawals from your account. This information is also passed on to the Internal Revenue Service, so you need to account for this when you file your income tax returns. Declare the amount of your withdrawal that is used for qualified education expenses on line 2 of Form 5329. Enter the code "08" as the exemption number. If any of your withdrawal is not for education expenses and you are not at least age 59 1/2, you must calculate the additional tax penalty from Form 5329 on line 58 of Form 1040.

Other Nontaxable Education Benefits

Making a withdrawal from your IRA for qualifying education expenses does not guarantee the entire amount of your withdrawal is not subject to penalties. You must consider any other tax-free education benefits that you or the student have received. This includes Pell grants, educational IRA benefits and any employer tax-free education benefits. For example, if you have incurred $3,000 in qualified education expenses and you received $2,000 from your employer in tax-free education benefits, you can withdraw up to $1,000 from your IRA to pay for education expenses without penalties. If you withdraw $2,000 from your IRA, you will need to pay any applicable penalties on the additional $1,000 in withdrawals.

Considerations

Unless you are withdrawing Roth IRA contributions, or nondeductible traditional IRA contributions, the amount you withdraw from your IRA for education expenses will increase your taxable income. This can affect your eligibility for other forms of financial aid, such as student loans or other grants. If possible, you can avoid any problems with this by withdrawing from your IRA during the qualifying student's senior year, when all financial aid is already in place and cannot be affected by changes in income.

• IRS: Publication 970, Tax Benefits for Education
• Bankrate.com: IRA Withdrawal for Kids' Education Expenses
• Kiplinger: Tax Breaks for Education Expenses
• National Center for Education Statistics: Fast Facts
• IRS: Form 1040 -- U.S. Individual Income Tax Return
• IRS: Instructions for Form 5329

Craig Woodman began writing professionally in 2007. Woodman's articles have been published in "Professional Distributor" magazine and in various online publications. He has written extensively on automotive issues, business, personal finance and recreational vehicles. Woodman is pursuing a Bachelor of Science in finance through online education.

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Can i withdraw funds from my ira for educational expenses, ira distribution: can i give to a child while i am alive, deductions from federal income tax for children attending college, how to use a roth ira for college tuition, can you borrow from your retirement account to pay for college, do i need a 1099-r form when i withdraw my ira, can i withdraw from my sep-ira to pay for my kids' college, how to claim ira money used to pay medical bills, can early distributions from retirement plans be used to pay college tuition, when can i withdraw from my ira without penalties, the effect of roth iras on pell grants, medical ira rules.

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Can You Withdraw from a 401K for Education?

Written by Shannon Vasconcelos on January 10th, 2023

• paying for college ,
• Employers can limit access to 401ks while you are still employed by the company sponsoring the plan. While tuition payments generally qualify for an in-service hardship withdrawal, you may be required to document that you’ve exhausted all other college funding options.
• Traditional 401k withdrawals are subject to taxation at your ordinary income tax rate. When your children are in college, you are likely in your peak earning years and in a higher tax bracket than you will be in during retirement.
• If you are not yet 59 ½ years old, 401k withdrawals are also subject to a 10% early withdrawal penalty. While IRAs offer an exception to the early withdrawal penalty for college expenses, early 401k withdrawals are always subject to a 10% penalty—no exceptions.
• Traditional 401k withdrawals are reported as income in the year that you make the withdrawal, increasing your Adjusted Gross Income (AGI). This income increase may not only bump you into a higher tax bracket, but could also reduce financial aid eligibility in a future academic year. To minimize the impact on financial aid, limit 401k withdrawals to your child’s last 2 ½ years of college.
• Most 401k loan programs only allow you to have one loan outstanding at a time. Therefore, you must borrow whatever you need to cover all four years of college all at once (up to a maximum of $50,000 or half the account value, whichever is lower).
• Furthermore, most 401k loans must be paid back within five years. If you’re borrowing enough to cover four years of costs and paying it off in five years, you’re actually not saving much in terms of monthly cash flow over simply paying the four years of costs as they arise over four years. If you can afford to pay back your 401k loan in a five-year time frame, you can probably afford to pay for college out-of-pocket and don’t need to borrow at all.
• If you separate from your employer while your 401k loan is outstanding, the full balance of the loan becomes due by the following tax deadline. If not paid in full by this date, the loan is converted to a distribution, with all tax and penalty repercussions listed in the withdrawal section above.
• In addition, the benefit to utilizing a traditional 401k is that you get to set aside money on a  pre -tax basis. If you borrow a 401k loan, you pay yourself back interest with  after -tax money. A 401k provides no separation of after-tax interest payments from pre-tax contributions, so when you begin withdrawing from your account in your golden years, you have to pay taxes on the after-tax portion of your withdrawals again! This is one of the very rare occasions in the U.S. tax code where you actually pay taxes on the same money twice. However necessary they may be to the operation of our civil society, most of us don’t particularly enjoy paying taxes. We certainly don’t want to pay them twice!

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How a 401(k) hardship withdrawal works

By Kyle Ryan

We all know that 401(k) accounts are meant for retirement savings. But we also all know that once in a blue moon, a situation arises — a big unexpected medical bill, or a down payment on a home — where we wish we could tap some of those funds in our 401(k) .

Before we dive in, I’m going to say this right upfront: it’s never a good idea to take money from your retirement fund if you can help it. Early withdrawals can carry hefty penalties and taxation, and you can rob yourself of the power of compounding earnings if you take funds out of your 401(k) that could otherwise potentially be growing.

If you do find yourself in a situation where it’s unavoidable to withdraw funds from your 401(k) early, there is something called a 401(k) hardship withdrawal that might allow you to access your contributions.

It’s up to the plan sponsor to decide whether to allow hardship withdrawals from the plan; however, most 401(k) plans do allow participants to make these kinds of withdrawals.

What is a hardship withdrawal?

As the name implies, 401(k) hardship withdrawals are designed to let participants withdraw money from their retirement plans if they’re facing certain financial hardships. But the IRS’ definition of hardship is rather broad. Hardship withdrawals are currently allowed for one of the following reasons:

• Medical expenses incurred by the participant or the participant’s spouse, dependents or beneficiaries.
• The purchase of a home if the home will serve as a primary residence, not an investment property.
• To prevent eviction from or foreclosure on a primary residence.
• Funeral expenses for the participant or the participant’s spouse, dependents or beneficiaries.
• Tuition and related expenses (such as fees and room and board) for the next year of post-secondary education for the participant or the participant’s spouse, dependents or beneficiaries.
• Expenses that are necessary to repair damage to the participant’s primary residence that would qualify for a casualty deduction.

Empower research shows that new hardship withdrawals stacked up to $9,926 in 2023. More than a quarter of surveyed Americans say they are very likely (10%) or somewhat likely (17%) to take out a loan or hardship withdrawal in the next six months.

Drawbacks of making hardship withdrawals

Keep in mind that just because you are facing one of these financial hardships doesn’t mean that taking out a hardship withdrawal is the best financial move. There are several potential drawbacks to making hardship withdrawals.

Perhaps the biggest disadvantage is that regular income taxes will be due on the funds taken out during the year in which they’re withdrawn. And if you’re under age 59½, a 10% early withdrawal penalty may also apply. There are a few exceptions to the early withdrawal penalty , including medical debt that exceeds 7.5% of your adjusted gross income (AGI).

If you don’t qualify for one of these exceptions and you are under 59½, you could receive significantly less money than the amount you take out via a hardship withdrawal. For example, if you’re in the 22% tax bracket and make a hardship withdrawal of $10,000, you’ll only retain $6,800 after subtracting $3,200 in taxes and penalties.

Another big drawback to making hardship withdrawals is that this could jeopardize your ability to enjoy a financially comfortable retirement. Every dollar withdrawn from your 401(k) early is a dollar that isn’t there for retirement. In addition, you lose the opportunity for these funds to grow on a tax-deferred basis over the long term, which could potentially grow your nest egg even more.

Our take: A last resort financing option

In most instances, 401(k) hardship withdrawals should be considered a last resort for obtaining funds, even if a particular situation qualifies as a hardship. The taxes and penalties associated with hardship withdrawals and the impact such withdrawals may have on your retirement finances can make them an expensive source of funds.

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Kyle Ryan is the Executive Vice President, Personal Wealth Advisory at Empower. A CERTIFIED FINANCIAL PLANNER™ professional, he is responsible for delivering an industry leading asset growth and retention wealth management client experience.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. No part of this blog, nor the links contained therein is a solicitation or offer to sell securities. Compensation for freelance contributions not to exceed $1,250. Third-party data is obtained from sources believed to be reliable; however, Empower cannot guarantee the accuracy, timeliness, completeness or fitness of this data for any particular purpose. Third-party links are provided solely as a convenience and do not imply an affiliation, endorsement or approval by Empower of the contents on such third-party websites.

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IRS Final Rule Eases 401(k) Hardship Withdrawals, Requires Amending Plans

Changes free up funds for emergencies but could hurt workers' savings

Making hardship withdrawals from 401(k) and 403(b) retirement plans soon will be easier for plan participants, and so will starting to save again following a hardship withdrawal.

On Sept. 23, the IRS published in the Federal Register a final rule that relaxes several existing restrictions on taking hardship distributions from defined contribution plans. Some of these changes are mandatory, requiring employers to make the changes by Jan. 1, 2020, while others are optional.

Unlike loans, hardship withdrawals are not repaid to the plan with interest, so they permanently reduce the employee's account balance. Hardship withdrawals also are subject to income tax and, if participants are younger than age 59½, a 10 percent early withdrawal penalty. For these reasons, withdrawals should be a last-ditch option for employees facing financial hardship.

"While many loan-takers default, at least there's a good chance that the loan will be repaid," said Aaron Tabela, chief marketing officer at Custodia Financial, which provides retirement savings loan insurance. "With hardship withdrawals, the leakage is permanent."

The IRS had issued a proposed regulation on Nov. 9, 2018, and the agency described the final regulations as "substantially similar to the proposed regulations" although some points were clarified.

The rule does not change that a 401(k) plan may, but is not required to, provide for hardship distributions.

What's Changing

Among its key provisions, the final rule will do the following:

•  Eliminate the six-month contribution-suspension requirement.

As called for in the Bipartisan Budget Act passed in February 2018, the final rule eliminates the suspension period that barred participants who take a hardship distribution from making new contributions to the plan for six months. Starting Jan. 1, 2020, plans will no longer be able to suspend contributions following a hardship distribution.

Eliminating the contribution suspension "could have a mixed effect on leakage from 401(k) plans" by encouraging more hardship withdrawals but letting those who take distributions rebuild their savings sooner, said Lori Lucas, president and CEO of the nonprofit Employee Benefit Research Institute in Washington, D.C.

Employees often "do not continue saving for their retirement [after the six-month suspension] and often miss out on the company match," said Robyn Credico, practice leader of defined contribution consulting at Willis Towers Watson, an HR advisory firm.

The new rule removes a requirement that participants first take a plan loan, if available, before making a hardship withdrawal. Unlike the elimination of the six-month suspension period, this change is not mandatory, so plans can continue to require participants to take a plan loan before being eligible for a hardship withdrawal.

"Many plan sponsors view [the loan-first requirement] as desirable, since it minimizes plan leakage," said Michael Webb, vice president at Cammack Retirement Group, a benefits consultancy in New York City.

•  Make earnings available for withdrawal.

Effective in 2020, earnings on 401(k) contributions can be distributed for hardships, as can profit-sharing and stock-bonus contributions. Previously, employees could only withdraw contributions, not earnings.

Earnings on 403(b) contributions would remain ineligible for hardship withdrawals because of a statutory prohibition that Congress didn't amend.

•  Ease hardship verification.

Under the rules currently in place, plan administrators must take into account "all relevant facts and circumstances" to determine if a hardship withdrawal is necessary. The new rule requires only that a distribution not exceed what an employee needs and that employees certify that they lack enough cash to meet their financial needs. Plan administrators can rely on that certification unless they have knowledge to the contrary. Plans are required to apply this standard starting in 2020.

"The IRS retained the requirement from the proposed regulations that the plan administrator may rely on the employee's representation, unless the plan administrator has actual knowledge of the contrary ," Webb noted. Beginning in 2020, "an employee can make a representation that he or she has insufficient cash or other liquid assets reasonably available to satisfy a financial need, even if the employee does have cash or other liquid assets on hand, provided that those assets are earmarked to pay an obligation in the near future" such as rent, he explained.

Employee self-certifications of need for a hardship withdrawal can be made over the phone, provided that the call is recorded, the final rule clarified, or can be made in writing or by e-mail, for instance. "Plan administrators who self-administer hardship distributions may want to establish an electronic process for receiving employee representations such as through e-mail or an intranet site ," attorneys at law firm Bradley advised.

"Employers didn't like figuring out when a distribution is necessary. Now there's a straightforward three-part test that covers the employer ," Forbes reported, the three parts being:

• The employee must first access other employer plan money if available, such as deferred compensation.
• The employee signs off that he or she has insufficient cash or other liquid assets reasonably available.
• The plan administrator signs off that he or she doesn't have any reason to believe the employee could do without the hardship withdrawal.

•  Provide disaster relief.

To take a hardship withdrawal, employees currently must show an immediate and heavy financial need that involves one or more of the following: 

• Purchase of a primary residence.
• Expenses to repair damage or to make improvements to a primary residence.
• Preventing eviction or foreclosure from a primary residence.
• Post-secondary education expenses for the upcoming 12 months for participants, spouses and children.
• Funeral expenses.
• Medical expenses not covered by insurance.

The final rule adds a seventh safe harbor category for expenses resulting from a federally declared disaster in an area designated by the Federal Emergency Management Agency.

"Making expenses related to certain disasters a safe harbor expense is intended to eliminate any delay or uncertainty concerning access to plan funds that might otherwise occur following a major disaster ," noted Nevin Adams, chief of communications at the American Retirement Association in Arlington, Va., which represents retirement plan sponsors and service providers.

According to the IRS, the agency will no longer need to issue special disaster-relief announcements to permit hardship withdrawals to those affected by federally declared disasters.

Plan Amendments Required

401(k) plans that permit hardship distributions will need to be amended to reflect these new rules by Dec. 31, 2021, but operational changes will be needed to comply with the new regulations by Jan. 1, 2020 , attorneys at law firm Proskauer pointed out. "Plan sponsors that previously took action in response to the proposed regulations should review prior plan amendments and administrative changes to confirm operational and plan document compliance with the final regulations," they added.

Adams said "the regulations note that the amendment deadline for 403(b) plans is March 30, 2020, but indicate the Treasury and IRS are considering extending that deadline for the adoption of amendments to conform to the final hardship regulations."

Joshua Rafsky, an attorney in the Chicago office of Jackson Lewis, advised that "plan administrators may also want to consider whether updates are needed to the plan's summary plan description and other communications documents that describe the plan's hardship rules, and to election forms and online election pages."

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement ]

Related SHRM Articles:

IRS Clarifies Amendment Period for Final Hardship Withdrawal Regulations , SHRM Online , December 2019

Hardship Distributions Rule Reflects a Decade of Legislative Changes , SHRM Online, October 2019

Retirement Plans Are Leaking Money. Here’s Why Employers Should Care , SHRM Online , October 2017

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Employee Benefits & Executive Compensation Advisory : Final Hardship Distribution Rules Are Here: Does Your 401(k) or 403(b) Plan Comply?

Our Employee Benefits & Executive Compensation Group examines the numerous changes – mandatory and permissible – plan sponsors can make to their 401(k) or 403(b) plans in light of new regulations for hardship distributions.

• When do you need to amend your plan?
• What are the mandatory and permissible changes?
• What next steps should you take?

The IRS published final regulations relating to hardship distributions from 401(k) and 403(b) plans on September 23, 2019. These regulations reflect the changes made by both the Tax Cuts and Jobs Act of 2017 and the Bipartisan Budget Act of 2018. The final regulations are substantially similar to the proposed regulations that were released in 2018 and state that “plans that complied with the proposed regulations will satisfy the final regulations.” However, all plan sponsors should review and, if necessary, amend their 401(k) and 403(b) plans to ensure compliance with the final regulations.  Plan Amendment Timing

Plan sponsors may need to amend their plans to comply with the mandatory provisions of the final regulations, and such amendments must be effective no later than January 1, 2020. Each plan is different, and whether an amendment is required will depend on the terms and operation of the plan. If an amendment is required, the deadline for adopting such an amendment differs depending on the type of plan: 

• Individually designed 401(k) plans must amend by the end of the second calendar year that begins after the issuance of the Required Amendments List, which will be December 31, 2021, if the final regulations are included in the 2019 Required Amendments List. 
• Preapproved 401(k) plans must amend by the 2020 tax-filing deadline, inclusive of any extensions.
• 403(b) plans must amend by March 31, 2020. However, the Treasury Department and IRS are considering providing for a later amendment deadline for these plans that would be issued in separate guidance. 

Plan sponsors may also choose to amend their plans to comply with permissible, but non-mandatory provisions of the final regulations. Timing for these permissible changes will depend on when the plan provision is adopted operationally.  Next Steps for Plan Sponsors

In preparation for the January 1, 2020 effective date of these hardship regulations, plan sponsors and administrators should: 

• Determine what provisions will be adopted on what date. Mandatory changes must be effective no later than January 1, 2020. Plan sponsors may also choose whether to adopt an earlier effective date, such as January 1, 2019, for some provisions. If any provisions were adopted operationally in 2019, a January 1, 2019 effective date may be appropriate, and such amendments should be adopted no later than December 31, 2019.
• Update hardship withdrawal provisions on participant communications, including summary plan descriptions and safe harbor notices, if applicable. Keep in mind that safe harbor notices for the 2020 plan year must be provided at least 30 days before the beginning of the plan year. If a safe harbor notice describes hardship withdrawal provisions in detail and if a description of the new hardship withdrawal provisions is not already included in the safe harbor notice, participants must be provided with an updated safe harbor notice reflecting the new hardship withdrawal provisions and must be given a reasonable opportunity to change their cash or deferred election. 

Background 

Active plan participants are permitted by the Internal Revenue Code to obtain a distribution from their plan account if they are facing a financial hardship. These distributions are commonly known as “hardship distributions.” Many plans have already been administering hardship distributions for several years and are already familiar with the requirements, but in general for a distribution to qualify as a hardship distribution, the distribution must satisfy the following two-pronged test: 

Prong 1: The distribution must be made on account of an “immediate and heavy financial need”

While this can be determined on a facts and circumstances basis, the IRS has previously provided a safe harbor list of financial needs that will be deemed to constitute an “immediate and heavy financial need,” including:

• Expenses for medical care for the participant, the participant’s spouse, or dependents.
• Costs directly related to the purchase of a principal residence for the participant (excluding mortgage expenses).
• Post-secondary education expenses, including tuition, related educational fees, and room and board expenses for the next 12 months for the participant or the participant’s spouse, children, or dependents.
• Payments necessary to prevent the eviction of the participant from the participant’s principal residence or foreclosure on the mortgage on that residence.
• Funeral expenses for the participant or the participant’s spouse, children, or dependents.
• Expenses for the repair of damage to the participant’s principal residence that would qualify for the casualty deduction under Section 165. 1  

Prong 2: The amount must be necessary to satisfy the financial need

Again, this can be determined under a facts and circumstances basis or under an IRS safe harbor. If used, the previous IRS safe harbor required that: 

• The distribution does not exceed the amount of a participant’s need.
• The participant has obtained all other currently available distributions and nontaxable loans under the plan and all other plans maintained by the employer.
• The participant is prohibited from making elective deferrals or contributions to the plan or any other plan maintained by the employer for at least six months after receipt of a hardship distribution.

The new hardship regulations make changes to both of these prongs. Some of the changes are mandatory for plan sponsors to adopt, while other changes are permissible, but not required.  Mandatory Changes

There are no mandatory changes made to Prong 1 of the existing hardship requirements. The only mandatory changes affect Prong 2.  New determination for satisfaction of financial need

The final regulations change Prong 2 to incorporate a single general standard for determining whether a distribution is necessary. Under this new standard: 

• The participant must have obtained all other available distributions from all the employer’s plans.
• The participant must represent that he or she has insufficient cash or other liquid assets “reasonably available” to satisfy the need. The “reasonably available” standard can be satisfied even if the participant has cash or other liquid assets on hand, but those assets are earmarked for other purposes (for example, rent).
• The plan administrator must not have actual knowledge to the contrary. 

This new certification standard in Prong 2 does not replace or eliminate the substantiation and documentation standards required to show proof of actual expenses incurred found in the safe harbor list of permissible expenses in Prong 1. Plan administrators and recordkeepers should continue to obtain source documents or rely on the summary model as detailed in the Internal Revenue Manual in addition to seeking this new certification from employees.  In addition, plan administrators should consider how to communicate with their recordkeepers to coordinate situations when the plan administrator may have actual knowledge that is contrary to a plan participant’s certification. 

Six-month suspension of contributions is no longer permissible

Many plans previously suspended participant contributions for six months following a hardship withdrawal. The final regulations no longer allow any automatic suspension for plan years starting January 1, 2020 or later. This prohibition on suspensions applies to qualified plans, 403(b) plans, and eligible 457(b) plans. However, the final regulations clarify that nonqualified deferred compensation plans subject to 409A that provide for a six-month suspension may retain their suspension provisions (or, to the extent consistent with 409A, remove them).  Permissible Changes

Permissible changes affect both prongs of the existing hardship requirements. In addition, plan sponsors may adopt a permissible change affecting the available sources of funds for hardship withdrawals.  Additional permissible hardship withdrawal safe harbor (Prong 1)

The safe harbor list of expenses that are deemed to constitute an “immediate and heavy financial need” is modified and expanded by adding expenses and losses (including loss of income) incurred by a participant on account of a disaster declared by FEMA, provided the participant’s principal residence or principal place of employment at the time of the disaster was in the designated disaster area. Additional permissible recipient of hardship withdrawals (Prong 1)

The new “immediate and heavy financial need” safe harbor provisions state that medical expenses, tuition and educational expenses, and funeral or burial expenses required for a participant’s “primary beneficiary” under the plan would also qualify as a hardship withdrawal. Before this change, these withdrawals are limited for the benefit of certain specified relatives or dependents.  The regulations define the term “primary beneficiary” broadly to include any person entitled to receive a portion of the account on the participant’s death. A participant could name an unrelated individual as a primary beneficiary for a small percentage of the participant’s account and then take a hardship withdrawal to pay the individual’s otherwise qualifying tuition, medical expenses, or funeral or burial expenses. This represents a planning opportunity for participants in plans that permit this change because it significantly expands the universe of people whose needs may now qualify for a hardship distribution.  Amended application of personal casualty loss (Prong 1)

Separate from the new hardship regulations, the Tax Cuts and Jobs Act added a new Section 165(h)(5) to the Code. This new section provides that, for taxable years 2018 through 2025, the deduction for a personal casualty loss is generally only available to the extent the loss is attributable to a federally declared disaster. The final hardship regulations clarify that for purposes of the “immediate and heavy need” safe harbor provisions, Section 165(h)(5) can be ignored. Plans that reference the casualty loss deduction in Section 165 may need to be amended to clarify that Section 165(h)(5) does not apply.  Plan loans are no longer required to demonstrate a financial need (Prong 2)

Participants are no longer required to take out all available plan loans before making a hardship withdrawal to demonstrate a financial need.  Additional permissible sources of hardship withdrawals

The regulations expand the sources of hardship withdrawals to include QNECs, QMACs, safe harbor contributions, and earnings on all these amounts regardless of when contributed or earned. Previously, only participant elective contributions (but not earnings thereon) were eligible for a hardship withdrawal.  QNECs and QMACs in a 403(b) plan that are in a custodial account continue to be ineligible for distribution on account of hardship.  Conclusion

The final regulations provide helpful guidance on both mandatory and permissible changes to hardship withdrawal procedures. Plan sponsors should closely review their hardship withdrawal procedures to determine compliance with mandatory provisions and consider whether to adopt any permissible changes. Please do not hesitate to contact your Alston & Bird attorney if you have any questions about hardship withdrawals or if we can assist you in amending your 401(k) or 403(b) plan.

1  The list of hardships is a general summary and is not intended to outline all the requirements for complying with the IRS hardship safe harbor.

• Advisories November 2, 2022 Employee Benefits & Executive Compensation Advisory : Retirement Plan Amendments and 2022 Year-End Action Items Our Employee Benefits & Executive Compensation Group reminds plan sponsors to get ready for 2022 IRS year-end amendments and offers year-end action items.
• Employee Benefits & Executive Compensation

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Understanding 401(k) and IRA Withdrawals for Education Expenses

A student's education expenses may be reduced when a parent uses their tax-advantaged retirement account to help cover tuition and other related costs. With many students graduating with college loan debt, using a 401(k) or IRA may help lessen the burden of paying off education-related debt. However, before deciding to withdraw from a 401(k) or an IRA, knowing the rules and how they may impact you is essential.

Usually, if one withdraws money from a 401(k) or IRA before age 59 1/2, they will pay a 10% penalty and taxes on the withdrawal. But, the 10% penalty does not apply to 401(k)s and IRA withdrawals when used for 'qualified' education expenses. The IRS views qualified education expenses as the amounts paid for tuition, fees, and other related expense for an eligible student that are required for enrollment or attendance at an eligible educational institution. Qualified expenses include:

• Tuition and enrollment fees
• Books and equipment
• Student activity fees

These expenses are not considered qualified expenses:

• Room and board
• Medical expenses (including student health fees)
• Transportation
• Similar personal, living, or family expenses
• Sports, games, hobbies, non-credit courses

Here's what you need to know when using your 401(k) or IRA for education expenses:

401(k) withdrawals- If your employer's 401(k) plan allows for withdrawals for education expenses, you can withdraw from your 401(k) and avoid the IRS' 10% early withdrawal penalty. You may also take a loan from your 401(k) plan; visit with your plan administrator or human resources department to understand how the rules may impact you.

If you take a loan, you may be able to take a tax credit when you file taxes for the year you paid the expenses; however, not in the year, you get the loan or the year you repay the loan. Because this may need clarification, consult your tax professional before taking a 401(k) loan.

Remember that penalty-free does not mean tax-free. Since contributions to a 401(k) are made pre-tax, taxes will be due on the amount you withdraw for education expenses. It's essential to keep records of each education expense for tax filing purposes.

401(k) Roth IRA withdrawals- The same rules as 401(k) withdrawals apply to a Roth 401(k), but only if the employer's plan permits withdrawals for qualified education expenses.

IRA withdrawals- IRA withdrawals are IRS 10% penalty-free if used to pay for qualified education expenses, regardless of the account owner's age. However, taxes will be due on the withdrawal amount in the year taken.

Roth IRA withdrawals- Contributions to a Roth IRA can be taken out penalty-free for qualified education expenses at any time after the account has been open for at least five years, even if the account owner is under age 59 1/2. Since Roth IRA contributions are made with after-tax dollars, no taxes are due on the withdrawal.

Investing in education for your child is an investment that pays off over time. Suppose you are considering a 401(k) or IRA withdrawal to help pay college expenses for your child. In that case, your financial professional can help you understand how taxes and early withdrawal penalties may impact your situation.

Important Disclosures:

Content in this material is for educational and general information only and not intended to provide specific advice or recommendations for any individual.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by Fresh Finance.

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Can 401(k) Be Used for Education

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on September 08, 2023

Are You Retirement Ready?

Table of contents, understanding 401(k) plans.

401(k) plans , named after the tax code that governs them, are tax-advantaged, defined-contribution retirement accounts typically offered by employers. They enable employees to save a portion of their pre-tax salary, reducing their annual income tax bill.

While these plans are primarily designed to foster retirement savings by providing tax incentives, under certain conditions, they can also be used for other purposes like education expenses.

However, despite the temptation to use these funds for immediate needs, it's vital to remember that the main purpose of a 401(k) is for retirement .

Tapping into it prematurely may address current financial requirements but could potentially jeopardize future financial stability.

Therefore, careful planning is needed before redirecting 401(k) funds for non-retirement purposes.

Using a 401(k) for Education Expenses

401(k) withdrawals for education costs.

Under certain conditions, you can use your 401(k) for education expenses. However, the process isn't as straightforward as merely taking money out of a traditional savings account.

If you're under the age of 59½, any withdrawal you make from your 401(k) is generally subject to income tax plus a 10% early withdrawal penalty .

There are, however, some exceptions to this rule, including certain allowable hardship withdrawals and loans.

Essential Conditions for Utilizing 401(k) Funds for Education

There are two main ways to use your 401(k) for education expenses without incurring the standard penalties: through hardship withdrawals and loans.

Hardship Withdrawals

Hardship withdrawals from a 401(k) are permissible when there's an immediate and substantial financial necessity, such as education expenses.

Nevertheless, the Internal Revenue Service (IRS) mandates that these withdrawals should only occur after all other distribution and loan avenues have been exhausted.

This method, while accessible, should be a last resort due to the potential impact on your retirement savings .

• 401(k) Loans

A more flexible option for accessing your 401(k) for education costs is taking a loan against your retirement account. The loan limit is typically the lesser of $50,000 or half of your vested account balance .

A significant advantage of this option over hardship withdrawals is that the money repaid, including interest , is re-contributed to your account, thereby mitigating some of the impact on your future retirement funds.

Advantages of Using 401(k) Funds for Education

Tax benefits.

Using a 401(k) loan for education expenses may allow you to avoid the 10% early withdrawal penalty and potentially save on taxes .

If the loan is repaid within the specified period (usually five years, unless it's used to buy a primary home), the only cost is the interest — which goes back into your account.

Flexibility

The funds from a 401(k) loan can be used for any purpose, including education costs. This includes tuition, fees, and other associated expenses for higher education.

As long as you can demonstrate that the expenses are necessary and meet the loan terms, you can use a 401(k) loan to help finance an education.

Potential Returns

If your 401(k) is performing well, it can be an attractive source of funding, especially when compared to high-interest credit cards or private student loans.

While you will lose out on potential gains while the money is withdrawn, you will be repaying the loan with interest, which is funneled back into your account.

Risks and Drawbacks of Using 401(k) Funds for Education

Early withdrawal penalties.

If you can't pay back a 401(k) loan within the specified period, it becomes classified as a distribution. This means the remaining balance is subject to income taxes and possibly a 10% early withdrawal penalty if you're under 59½.

Also, if you leave your job (or are let go) while you have an outstanding 401(k) loan, the remaining balance usually becomes due much sooner.

Long-Term Impact on Retirement Nest Egg

When you borrow from your 401(k), you're effectively reducing the amount of money that's invested for your retirement.

Even if you pay back the loan, the overall amount may be less than if you had left the money untouched due to missed investment gains during the loan period.

Tax Implications

Although 401(k) contributions are made with pre-tax dollars, both the principal and interest on a 401(k) loan must be repaid with after-tax dollars.

This effectively means you'll pay taxes twice on the same money: once when you repay the loan and again when you withdraw the funds in retirement.

Alternatives to Using a 401(k) for Education Expenses

529 college savings plan.

A 529 plan is a tax-advantaged savings plan designed specifically for education expenses. These plans can be a more efficient way to save for education, offering tax-free growth and tax-free withdrawals for qualified education expenses.

They also have high contribution limits , and anyone can contribute to a plan, making them a great option for family members or friends who want to help.

Scholarships and Grants

Scholarships and grants offer another way to finance education without dipping into retirement savings. They are often need-based or merit-based and don't have to be repaid. The application process can be competitive, but the potential benefits are significant.

Student Loans

Student loans are another common way to pay for education.

While these do need to be repaid with interest, federal student loans often have lower interest rates and more flexible repayment options than other types of debt. Plus, unlike with a 401(k) loan, there's no risk to your retirement savings.

Is Using a 401(k) for Education Right for You?

Key factors to consider in the decision-making process, potential return on education investment.

Before using your 401(k) for education, consider the expected return on investment (ROI) for the educational pursuit.

Will this education lead to a significantly higher income or new opportunities that outweigh the depletion of your retirement savings? If the potential ROI is not high, it might be wise to seek other financing methods.

Time Until Retirement

Your proximity to retirement is a key factor. If retirement is close, using your 401(k) funds might be risky, as it reduces the time for your investments to rebound and grow.

However, if you're further from retirement, you may have more time to replace the funds and recover from any potential investment losses.

Performance of 401(k) Investments

The current performance and future prospects of your 401(k) investments should also be taken into account. If your investments are doing well, withdrawing from the fund may mean missing out on potential earnings.

If the performance is mediocre, it might seem less risky to use these funds, but remember that market conditions can change.

Availability of Other Education Financing Resources

Examine all available education financing resources before tapping into your retirement savings. Other options might include grants, scholarships, work-study programs, or student loans.

These options could be a more financially prudent route than potentially jeopardizing your future retirement security.

Bottom Line

Using a 401(k) for education expenses can be advantageous. It can provide a tax-deferred way to save for education, and it can help you reach your retirement savings goals.

The convenience and flexibility offered by 401(k) withdrawals or loans for education are undeniably appealing.

Yet, it's crucial to remember that these choices come with potential pitfalls, such as early withdrawal penalties, long-term impacts on your retirement nest egg , and double taxation .

As such, alternatives like 529 plans, scholarships, grants, and student loans should be explored before tapping into your retirement savings.

Given the high stakes and long-term implications of this decision, professional advice from a financial planner or advisor can be invaluable.

To ensure your financial future remains secure, seek retirement planning services that can offer tailored strategies for your unique circumstances.

Can 401(k) Be Used for Education FAQs

Can you use my 401(k) for education expenses.

Yes, under certain conditions like hardship withdrawals or loans, you can use your 401(k) for education expenses.

What are the tax benefits of using a 401(k) for education?

If you take a 401(k) loan for education, you may avoid a 10% early withdrawal penalty and potentially save on taxes.

What are the drawbacks of using a 401(k) for education costs?

Drawbacks include potential early withdrawal penalties, a decrease in retirement savings, and double taxation upon repayment.

What are alternatives to using a 401(k) for education expenses?

Alternatives include 529 College Savings Plans, scholarships and grants, and student loans.

How can you decide if using a 401(k) for education is right for you?

Consider factors like potential education returns, time until retirement, 401(k) performance, and seek advice from a financial advisor.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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Retirement topics - Hardship distributions

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Although not required, a retirement plan may allow participants to receive hardship distributions. A distribution from a participant’s elective deferral account can only be made if the distribution is both:

• Due to an immediate and heavy financial need.
• Limited to the amount necessary to satisfy that financial need.

Immediate and heavy financial need

The employer determines a participant has an immediate and heavy financial need based on the plan terms and all relevant facts and circumstances.

• Consumer purchases (such as a boat or television) are generally not considered 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.

A distribution is automatically considered to be necessary to satisfy an immediate and heavy financial need if all of the following requirements are met:

• The distribution isn't greater than the amount of the immediate and heavy financial need, including the amounts necessary to pay any taxes resulting from the distribution.
• The employee has obtained all other currently available distributions (including distribution of ESOP dividends under section 404(k), but not hardship distributions) and nontaxable (at the time of the loan) plan loans, including all other plans maintained by the employer.
• The employee isn't allowed to make elective deferrals to the plan for at least six months after the hardship distribution.

Safe harbor distributions

• Effective Feb. 23, 2017, 401(k) plans may elect to use the "Summary substantiation method" for the six types of hardship distributions below.
• Effective March 7, 2017, 403(b) plans may elect to use the "Summary substantiation method" for the six types of hardship distributions below.

Under a “safe harbor” in IRS regulations, an employee is automatically considered to have an immediate and heavy financial need if the distribution is for any of these:

• Medical care expenses for the employee, the employee’s spouse, dependents or beneficiary.
• Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments).
• Tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents or beneficiary.
• Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.
• Funeral expenses for the employee, the employee’s spouse, children, dependents, or beneficiary.
• Certain expenses to repair damage to the employee’s principal residence.

Limited to the amount necessary

The amount of a hardship distribution must be limited to the amount necessary to satisfy the need. This rule is satisfied if:

• The distribution is limited to the amount needed to cover the immediate and heavy financial need, and
• The employee couldn't reasonably obtain the funds from another source.

Unless the employer has actual knowledge to the contrary, the employer may rely on the employee’s written statement that their need can’t be relieved from other available resources, including:

• Insurance or other reimbursement.
• Liquidation of the employee’s assets.
• The employee’s pay, by discontinuing elective deferrals and after-tax employee contributions.
• Plan loans or reasonable commercial loans.

An employee doesn’t have to use alternative resources if doing so would increase the amount of the need. For example, an employee requesting a hardship to purchase a principal residence doesn’t have to obtain a plan loan if the loan would disqualify the employee from obtaining other necessary financing.

Account balances eligible for hardship distributions

In a 401(k) plan, hardship distributions can generally only be made from accumulated:

• elective deferrals (not from earnings on elective deferrals)
• employer nonelective contributions (sometimes referred to as “profit-sharing contributions”) and
• regular matching contributions.

A plan may, but isn't required to, apply the same conditions to hardship distributions of employer nonelective and regular matching contributions as it applies to hardship distributions of elective deferrals. Some 401(k) plans may allow hardship distributions of certain kinds of contributions made to the plan before 1989.

If you are an employer and:

• You didn’t make hardship distributions according to your plan document, find out how you can correct this mistake.
• You made hardship distributions but your plan doesn’t have language permitting them, find out how you can correct this mistake.

Tax treatment of hardship distributions

Hardship distributions are subject to income taxes (unless they consist of Roth contributions). They may also be subject to a 10% additional tax on early distributions . Employees who take a hardship distribution can't:

• repay it to the plan, or
• roll it over to another plan or an IRA.

Changes coming for 2019

The Bipartisan Budget Act of 2018 enacted three changes to these rules, specifically:

• repealing the previously-required 6-month suspension of elective deferrals after a participant received a hardship distribution
• permitting amounts previously contributed as qualified non-elective or qualified matching contributions (QNECs/QMACs) to be available as a hardship distribution.
• removing the requirement to take available plan loans prior to requesting a hardship.
• Regulations are also proposed which would further:
• revise the applicable standards governing when a distribution can be made on account of hardship
• permit hardship distributions to participants seeking to repair a primary residence, even if that repair would not otherwise qualify for a casualty loss deduction
• apply most of these rules to participants in 403(b) arrangements

Although the Act is effective for hardship distributions made in 2019, taxpayers can rely on these rules for purposes of hardship distributions made in 2018 as well.

REG-107813-18 PDF  

• Retirement plans FAQs regarding hardship distributions
• Treasury Reg. Section 1.401(k)-1(d)(3)
• Do's and Don'ts of hardship distributions
• Hardship distribution tips from EP Exam
• 401(k) Plan hardship distributions - Consider the consequences

Should You Take a 401(k) Hardship Withdrawal Now?

(Photo by Christopher Pillitz/Getty Images)

If you need money badly and your 401(k) balance beckons, what's the best strategy?

Under most 401(k) plan rules, you can take a "hardship withdrawal" from your plan under certain circumstances, because of an "immediate and heavy financial need," according to the IRS. These are the kinds of expenses that qualify:

— Generally, expenses for medical care previously incurred by the employee, the employee’s spouse, or any dependents of the employee or necessary for these persons to obtain medical care;

— Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);

— Payment of tuition, related educational fees, and room and board expenses, for up to the next 12 months of post-secondary education for the employee, or the employee’s spouse, children, or dependents;

— Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence;

— Burial or funeral expenses for the employee’s deceased parent, spouse, children, or dependents; or

— Certain expenses relating to the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under IRC § 165.

While a hardship withdrawal sounds like a panacea under these conditions, it's hardly ideal. You would face a tax hit.

"Remember that when you've been approved for a withdrawal, you're not off of the IRS radar screen," notes the 401khelpcenter. "A hardship withdrawal is a taxable event, so you will have a mandatory 20 percent withholding tax taken out of the check. You may end up owing more, depending on your total income for the year. You may also be subject to the 10 percent penalty if you are under age 55."

Is the tax hit worth it? Let's do some math.

"The tax burden on early withdrawal hits you in two different ways," the 401khelpcenter continues. "First, your withdrawal is subject to ordinary income tax. For example, if you normally pay 28 percent federal tax and 4 percent state tax, then a $10,000 hardship withdrawal will lose $3,200 to the government."

"Second, your withdrawal may be subject to a 10 percent early-withdrawal penalty on the full amount. The only reason you wouldn't pay the penalty is if you are over age 55 or if the IRS grants you an exemption. Even though, in our example, you are paying $3,200 in taxes already, you still pay the 10 percent penalty on the full amount, or a penalty of $1,000."

"Put these two numbers together and you can see that the $10,000 withdrawal only leaves you with $5,800 after taxes. On average, you'll pay between 25 percent and 40 percent or more in taxes and penalties from your hardship withdrawal, according to retirement expert Ted Benna."

Ultimately, what looks like "free money" is actually a costly transaction that will take money out of your retirement kitty.

If you need to save money for college, consider 529 Savings Plans . For health expenses, a Health Savings Account is a much better vehicle. At the very least, though, an emergency savings account is always a good place to start. That way you avoid the nasty tax consequences of tapping into your retirement fund.

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Using your 401(k) to pay for educational expenses.

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By Jenn Pavlick

Sam Swenson

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Sam Swenson is a financial planner, New York State CPA, CFA charterholder, and freelance writer/editor. After nearly a decade in various Wall Street roles, Sam found a niche in creating objective, accessible, and actionable financial plans for everyday people. Sam has also published long- and short-form personal finance and investment planning content on various websites across the internet. Outside of work, Sam enjoys running, biking, reading, and philosophy, as well as spending time with his wife, daughter, and goldendoodle.

Updated on June 12, 2023

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A 401(k) plan is an employer-sponsored retirement savings account that allows employees to contribute a portion of their pre-tax earnings to a tax-deferred investment account. Typically, these funds are not available for withdrawal until you’re 59 1/2. However, in some unusual circumstances , you may be able to access the money early.

With the increasing cost of college and associated higher education expenses, many people are looking for alternative funding options to cover their child’s college education. One idea that has gained some attention is using your 401(k) to pay for educational expenses.

Before making that choice, it’s essential to understand the implications of using your retirement funds for college tuition and to understand your alternative options.

Here, we’ll cover everything you need to know about using 401(k) funds for education, including when it’s a good idea, the risks involved, and other alternative investment options. We’ll review the early withdrawal process, as well as the option to loan yourself money from your 401(k).

When Should You Consider Using Your 401(k) for Educational Expenses

Using your 401(k) to cover college expenses may seem convenient, but it’s crucial to consider what happens when you make this decision. Tapping into your retirement account and making an early withdrawal can have long-term implications for your own retirement down the line — and it can come with a costly near-term tax bill.

Because you made tax-deferred contributions to your pre-tax 401(k), you’ll need to pay income taxes on withdrawals, and, depending on how much you withdraw, taking money out can be quite costly. You may qualify for a hardship withdrawal when you take funds out to pay for higher education expenses, but you’ll still be facing a meaningful IRS bill.

As such, know that 401(k) withdrawals for educational expenses do not qualify for an early withdrawal penalty waiver, which means you’ll be on the hook for another 10% in addition to income tax.

Before cashing out your 401(k) to pay for college expenses, weigh the potential benefits against the long-term negative impact to your retirement savings. Tapping your 401(k) may be an appropriate choice only when you have exhausted all other options.

Before making this decision, ensure you’ve explored all your options with a professional.

Rules and Regulations for Using a 401(k) for Educational Expenses

If you decide to use your employer-sponsored 401(k) for educational purposes, be aware of the rules and regulations that govern these early withdrawals, which are not penalty-free:

• Typically, there is a 10% early withdrawal penalty for distributions made before 59½.
• Since the money was invested tax-deferred, you’ll need to pay income tax on the withdrawn amount , and state taxes may also apply depending on your location. Typically a withdrawal counts towards your taxable income for the year, which could push you into a higher tax bracket.

Another factor to consider is that financial aid is based on your Adjusted Gross Income (AGI). Withdrawing funds for higher education costs will boost your AGI for the year, potentially reducing the amount you’re eligible to receive through financial aid.

Speak to an advisor for specifics in your case. Consult with a financial advisor to determine your eligibility and try to get a sense of the tax liability associated with 401(k) withdrawals for qualified education expenses.

Steps to Withdraw from Your 401(k) for Educational Expenses

To withdraw retirement funds from your 401(k) for educational expenses, you can follow these general steps:

• Contact your plan provider to discuss your intentions and to learn about procedures or requirements specific to your plan.
• Once you understand the process and implications, if you move forward with the withdrawal, you’ll be asked to complete the necessary paperwork to unlock your retirement funds.
• Once everything is in order, the timeline for receiving funds will vary, so plan accordingly to ensure the funds are available when needed.

Because of the variability of the timeline, it’s smart to get this process underway in advance so you can avoid any gaps in funding needs or situations where you fail to meet lender requirements.

Loans, Repayment and Retirement Savings

So far, we have been discussing the option to take an early distribution from your 401(k). But there is also the possibility to loan yourself money from your 401(k), which can help you avoid the penalty fees, on the condition that you make timely payments (with interest) back to your retirement plan.

The IRS allows individuals to loan themselves either 50% of their 401(k) balance or $50,000—whichever number is lower. If you default on the plan loan or otherwise fail to pay back the funds, you’ll be taxed on the remaining loan balance as a distribution, and, if you’re under 59.5, may also be liable for 10% penalty.

If you do loan yourself 401(k) funds for educational expenses, it’s essential to replenish your retirement account and resume regular contributions in line with IRS rules:

• Typically, you’ll have five years to pay off your loan and make your account balance whole.
• You’ll be required to make regular payments comprised of principal and interest at least every quarter.
• 401(k) loan repayments can come out as deductions from your paycheck, but you may also be able to cut your 401(k) plan a check if you have other resources to settle your debt.

In addition to replenishing your funds, it’s essential to resume regular contributions to your retirement savings so that you can get back on track for retirement and make the most of compound growth.

When you make an early withdrawal or loan yourself funds from your retirement savings for education costs, you’ll likely face the following consequences:

• Additional stress on your retirement planning process
• Potential for costly expenses, like income taxes or early withdrawal penalties
• Foregone tax-deferred market gains from having your money out of the stock market
• Less disposable income until the loan is paid off (since a portion of your check will go to loan repayments)

It’s almost always a good idea to speak to a financial advisor who can help you balance the demands of paying for college with your own retirement planning. Sometimes, leaving the money invested in your 401(k) and pursuing other loan or grant options can be even more beneficial in the long run.

Alternative Options for Funding Education

Consider alternative options before using your 401(k) plan to fund education expenses. You can take many routes to fund your own or a family member’s education.

Here are a few:

• 529 plans : These are specifically designed for education savings and offer tax advantages and flexibility, but to get the maximum impact, you’ll need to start saving early.
• Student loans : Explore federal and private student loans, considering the pros and cons of each option by figuring the amount of debt that would be incurred as well the associated interest rate.
• Scholarships, grants, and other financial aid : There are options to receive funding based on merit, need, and other qualifying factors depending on the school or program and your personal circumstances.
• Work-study programs : These can be part of a financial aid package and are opportunities to make money while studying to help your child afford the educational experience.

Often, individuals will fund their education through a combination of the various options above.

To fully understand your options for funding your education in alignment with your financial goals and financial needs, complete the Free Application for Federal Student Aid (FAFSA) to see how much you might qualify for.

It is possible to use your 401(k) to withdraw funds or loan yourself money to pay for education expenses, but this decision can come with some negative implications for your retirement account long-term.

Using your 401(k) to pay for educational expenses is a decision that requires careful consideration, and you need to account for your individual financial situation, the effect it will have on retirement savings, and the other options available to you.

Before making a choice, weigh the pros and cons of this option and explore alternative funding sources, such as 529 plans, student loans, scholarships, financial aid, and grants.

Seek professional advice to ensure that you make well-informed decisions and strike the right balance between education expenses and long-term retirement planning.

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Can I Use My 401(k) to Pay Off My Student Loans?

• How Do 401(K) Loans Work?
• Employers Offer Alternatives to 401(k) Loans
• Can I Use My 401(k) as Collateral for a Loan?
• How to Pay Back a 401(k) Loan
• 401(k) Loan vs. IRA Withdrawal: What's the Difference?
• 401(k) Loans: Reasons to Borrow
• 8 Reasons to Never Borrow From Your 401(k)
• Are 401(k) Loans Taxed?
• How to Calculate Early Withdrawal Penalties on a 401(k) Account
• Can I Use My 401(k) to Buy a House?
• Will a Loan on My 401(k) Affect My Mortgage?
• Using Your 401(k) to Pay Off a Mortgage?
• Can I Use My 401(k) to Payoff My Student Loans CURRENT ARTICLE
• 401(k) Match for Student Loan Repayments: What You Need to Know

If you are over age 59½, you are free to use your 401(k) to pay for anything you like. If you are younger than that, you can still withdraw funds from your 401(k) to pay off college loans, but you will need to pay a 10% penalty tax on the amount of the withdrawal, in addition to any income tax that may be due. However, there are other ways to use retirement savings to pay for college expenses . For example, you can borrow from your 401(k) instead of taking out a student loan.

Key Takeaways

• If you are younger than 59½, you can’t withdraw funds from a 401(k) to pay off a student loan without paying a penalty.
• It’s possible to borrow from a 401(k) instead of taking out a student loan.
• A less appealing option is to take a withdrawal, which can be used to pay for tuition and education expenses, but it may be subject to penalties and taxes.
• It’s also possible to pay for education expenses with individual retirement account (IRA) funds without paying an early withdrawal penalty if you follow certain rules.

Instead of taking out traditional student loans, you may be able to fund your college education by taking a loan from your 401(k) . Rather than repaying a bank, you make payments of principal and interest back to your own retirement account.

Loans from your traditional or Roth 401(k) retirement account are limited to 50% of your vested account balance, up to $50,000. You may take out multiple loans at different times, but your maximum outstanding balance may not exceed $50,000. Keep in mind that plan sponsors aren’t obligated to offer 401(k) loans and can limit the amount and repayment terms to less than what is allowed by the IRS.

Qualified loans taken from your 401(k) are not subject to income tax , provided that the loan is paid off within a predetermined period. Generally, the borrowed funds must be repaid within five years in regular, substantially equal payments, at least quarterly. However, if you serve as a reservist in the U.S. military and are called to service, the term of your loan is extended to include the duration of your service.

There are also drawbacks to borrowing from your 401(k) that must be considered. One downside is that funds that are withdrawn from your account as a loan will lose out on potential tax-deferred growth on earnings. Another is that if you part ways with your employer, you must repay the loan by tax day—or six months after tax day, if you file for an extension.

A less appealing option to pay for higher education expenses with funds from your 401(k) is a hardship withdrawal . If you already attended college and used student loans to pay your tuition, a hardship withdrawal cannot be used to repay your loans.

However, if you plan on attending school in the future and cannot otherwise afford to pay your tuition, you may be able to withdraw money from your 401(k) to pay your tuition, room and board, and other related expenses using this tool.

Unlike a loan, funds taken as part of a hardship withdrawal cannot be paid back to your 401(k) account.

You may also be able to take a hardship withdrawal to pay the tuition and education expenses of a child, spouse, or dependent who is planning on attending school within 12 months. Either way, if you are younger than 59½, or 55 under certain circumstances, you will need to pay a 10% penalty on the amount withdrawn in addition to income taxes.

To qualify for a hardship withdrawal to fund your education, you must meet certain criteria. Firstly, you must be able to prove your need is immediate and heavy. A student loan is not an immediate expense because it already provides for repayment over time. However, tuition for the upcoming school year does qualify as immediate.

For your need to be considered heavy, the expense must be important and large enough that it could not easily be met by working a few more hours or cutting out your weekly movie night.

Besides college tuition, other expenses that are considered immediate and heavy include permanent disability and qualifying medical expenses that exceed 7.5% of your adjusted gross income (AGI). In these instances, no 10% penalty is levied.

When assessing your need, your plan administrator evaluates any other assets you have at your disposal, such as checking or savings accounts, investments, and property holdings. If liquidating one of your other assets enables you to pay your tuition without taking a distribution from your 401(k), then your hardship withdrawal might be declined. Also, if your plan allows you to obtain a 401(k) loan to satisfy the need, your withdrawal might not qualify as an immediate and heavy need.

If you have an individual retirement account (IRA), you can use funds from it to pay education expenses for you or your spouse, children, or grandchildren without paying the 10% penalty if you follow specific rules .

While IRA withdrawals cannot be used to pay student loans , they can be used for qualified education expenses at an eligible institution. Qualified expenses include tuition, books, and supplies, among others.

There is an alternative to using funds from a 401(k) to pay a qualified student loan, thanks to the Setting Every Community Up for Retirement Enhancement (SECURE) Act . Signed in December 2019, the law expands the rules for 529 plans , allowing account holders to withdraw a lifetime maximum of $10,000 to pay student debt of the plan's beneficiary or their sibling. The withdrawal is tax- and penalty-free at the federal level. But it may be considered a non-qualified distribution in your state, so it's worth verifying how it is treated at the state level.

Student Loan Repayment Options

If you are having trouble repaying your student loans, you have options. Refinancing your student loans may lower your rate or reduce your payments. If that’s not an option, it still might be worthwhile to work with your lender to see about forbearance programs. 

If you have federal student loans, you could be eligible for student loan forgiveness or deferment. Alternatively, if you’re just looking to pay off your student loan debt faster, you can make extra payments—such as using a side hustle to make extra money.

Can You Use a 401(k) to Pay Off Student Loans Without Penalty?

No, you will pay a penalty if you withdraw money from your 401(k)—unless you’re 59½ or older. Early withdrawals—that is, before you're 59½—come with a 10% penalty, in addition to the typical income tax on withdrawals from traditional (non-Roth) accounts.

With a Roth 401(k) , as long as you've had the account for five years and are older than 59½, withdrawals are tax and penalty-free.

What Are the 401(k) Hardship Withdrawal Rules?

Taking a hardship withdrawal for a 401(k) allows you to avoid the 10% early withdrawal penalty. Several situations qualify, including certain medical costs, principal residence purchases, funeral expenses, and post-secondary education expenses—but not student loans, however.

Can I Take an IRA Withdrawal to Pay Student Loans?

You can withdraw from your traditional IRA to pay student loans, but you will pay early withdrawal penalties if you’re 59½ or younger. Note that certain higher education expenses can be paid via an IRA penalty-free, but not student loans. The rules for withdrawing from a Roth IRA are more complex.

Taking a distribution to pay your student loans or a hardship withdrawal to pay for higher education expenses is typically not the most efficient use of your retirement savings, particularly if you are under age 59½.

Borrowing from your 401(k), if your employer allows it, can be an alternative to taking out a student loan, though it's important to weigh the pros and cons before doing so. And if you have an IRA, you can make a penalty-free withdrawal for qualified education expenses at an eligible institution.

Internal Revenue Service. “ 401(k) Resource Guide - Plan Participants - General Distribution Rules .”

Internal Revenue Service. " 401(k) Resource Guide - Plan Participants - General Distribution Rules ."

Internal Revenue Service. “ Retirement Topics - Exceptions to Tax on Early Distributions .”

Internal Revenue Service. " 401(k) Plan Fix-It Guide - Participant Loans Don't Conform To The Requirements Of The Plan Document And IRC Section 72(p) ."

Internal Revenue Service. “ Retirement Plans FAQs Regarding USERRA and SSCRA .”

Internal Revenue Service. “ Department of Treasury Letter ,” Page 1.

Internal Revenue Service. " Topic No. 558 Additional Tax on Early Distributions from Retirement Plans Other than IRAs ."

Internal Revenue Service. “ Qualified Education Expenses .”

Congress. " H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019 ."

Internal Revenue Service. " Hardships, Early Withdrawals and Loans ."

Internal Revenue Service. " Retirement Topics - Hardship Distributions ."

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The types of expenses that qualify for a TDA hardship withdrawal and the supporting documentation required are listed below. Please note that, if the documentation describes a hardship for a person other than yourself, you must also include proof of the other person's relationship to you ( e.g. , a 1040 form).

• Certain medical expenses for you, your spouse, a dependent, or child (including a child who does not qualify as a dependent for tax purposes) that are not covered by health insurance. Documentation required: Physician, hospital, and/or related bills.
• Tuition, related educational fees, and related room and/or board expenses for post-secondary education for the next 12 months of education for you, your spouse, a dependent, or child (including a child who does not qualify as a dependent for tax purposes). Documentation required: Outstanding itemized bill(s) (with name of student indicated and any financial aid) from the academic institution.
• Payment to prevent eviction from your principal residence or foreclosure on that residence. Documentation required: Valid eviction or foreclosure notice ( e.g. , letter from landlord, attorney, or representative indicating amount due and date of pending eviction or foreclosure).
• Costs directly related to the purchase of your principal residence (excluding mortgage payments) and/or additional costs ( e.g. , legal and/or other closing fees) associated with this purchase. Documentation required: Valid sales contract for purchase of principal residence and/or "good faith estimate" of any additional costs.
• Payment required for a new rental lease for your principal residence following eviction from a previous principal residence. Documentation required: New valid lease.
• Payments for burial or funeral expenses for your spouse, parent, dependent, or child (including a child who does not qualify as a dependent for tax purposes). Documentation required: Funeral home, cemetery, or related bills.
• Expenses for the repair of damage to your principal residence that would qualify for the casualty deduction under Section 165 of the IRC. Documentation required: Photograph(s) of damage; licensed contractor's estimate or bill(s) to repair the damage; and official proof that the damage will not be covered by insurance.

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