The IRS Code allows for certain penalty-free withdrawals, and gives the plan administrator the freedom to define certain other hardship exemptions. Certain kinds of retirement plan withdrawals are excluded from the 10% early withdrawal penalty tax.
These include medical expenses which exceed 7.5% or 10% of Adjusted Gross Income, distributions to the family members of active duty military personnel who have been called to active duty, and distributions needed if the participant becomes disabled.
“Hardship” withdrawals are a little fuzzier than this, however, and can be defined by each plan administrator in an unbiased manner. The IRS allows plan administrators to each define what constitutes a hardship, what withdrawals are permissible, and whether or not the participant is allowed to fully fund their account in the years after a hardship withdrawal has been taken.
The employee must be able to prove that an immediate and heavy expense is due, and that he or she is out of other resources. Examples of possible hardships include imminent foreclosure or eviction from a home, urgent home repairs such as roof damage, educational expenses, medical expenses, death, etc.
The hardship can also apply to family members and dependents. The employer must believe that the employee could not fund the need from any other source, including the liquidation of non-essential assets.
Surprisingly, hardship distributions are still generally subject to the 10% IRS early withdrawal penalty. Only the aforementioned standard exemptions are free and clear of the penalty.
403(b)s have the same stipulations, while 457 plans (for government employees) have a similar but slightly different criteria. Typically hardship withdrawals can only be made up to the amount contributed by the employee, unless the plan stipulates otherwise.
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