In today’s economic turmoil, many face hardship and need to use the funds in their retirement account in order to make ends meet. While withdrawing funds out of your retirement account is not a recommended strategy for a long term investment; however, if it is the inevitable last resource to cope with hardship, it is important to know and weight your options.
Depending on your employer’s retirement plan, you might be eligible for a loan or a hardship withdrawal. IRS defines the two options as follow:
A loan is an amount employees can borrow from their retirement plan accounts and then pay back with interest. As long as the employee repays the borrowed amount, it is not taxed and not penalized and the employee’s retirement plan account balance is restored by the amount borrowed as repayments are made. Employees are not required to prove financial hardship to get a loan.
Loan Tax Consequence: The law does not consider a loan taxable income as long as the employee repays the loan. If they fail to repay the loan, the unpaid amount is taxable income in the year they fail to repay it and is subject to an additional 10% early withdrawal penalty tax unless some exception to this early withdrawal tax applies.
A hardship withdrawal is an amount that employees can receive from their retirement plan accounts and do not have to pay back. Employees are usually required to provide proof of their hardship and, in some plans, cannot contribute to the plan from their wages for the next six months. Typically, hardship withdrawals are only for unforeseeable emergency expenses employees and/or their spouses, dependents, or beneficiaries are facing and are unable to pay using any other available resources, including loans, if available, from the plan. Depending upon the type of plan, these emergency expenses may include having to pay for: medical expenses; funeral expenses; repairs to their primary home after a fire or other damage; prevention of eviction or mortgage foreclosure.
Hardship Withdrawal Tax Consequence: The law considers the amount of a hardship withdrawal to be taxable income in the year the employee makes that withdrawal and it is subject to a 10% early withdrawal penalty tax unless (in addition to the regular federal and state tax) some exceptions to this early withdrawal tax applies.
Madina Traore, Bookkeeper
For more information please contact the Lumix Team.