Which is better hardship withdrawal or loan?
A 401(k) loan is generally more attainable than a hardship withdrawal, but the latter can come in handy during times of financial strife.
Disadvantages of a Hardship Withdrawal
The amount that is withdrawn cannot be repaid back into the plan. Hardship withdrawals are subject to income tax and will be reported on the individual's taxable income for the year. If the individual is below 59 years old, they may be required to pay a 10% penalty.
If you plan to retire soon (in five years or less), a 401(k) loan may not be the best option—you must repay the loan within that period to avoid penalties. In that case, a personal loan may be the better way to go. In most circ*mstances, borrowing from a 401(k) should be a last resort.
The Bottom Line
If you are facing financial hardship, it can make sense to take out a hardship personal loan, but it's also worth looking into government grants, home equity loans or HELOCs, or IRA or 401(k) hardship withdrawals.
Once you submit your hardship withdrawal application, it will be reviewed. Generally this takes less than a day. However, if there are any questions about your application, additional review time may be needed. Typically, this further review takes 5-7 business days.
If you're caught lying about legibility for a hardship withdrawal, you may face additional fees, fines, and even imprisonment. 401(k) plans are employee-sponsored plans, and lying about your financial situation in a legal declaration may result in a loss of trust from your employer.
A hardship distribution is a withdrawal from a participant's elective deferral account made because of an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need. The money is taxed to the participant and is not paid back to the borrower's account.
Key takeaways
A 401(k) loan may be a better option than a traditional hardship withdrawal, if it's available. In most cases, loans are an option only for active employees. If you opt for a 401(k) loan or withdrawal, take steps to keep your retirement savings on track so you don't set yourself back.
If you have a high-interest debt, such as from a credit card with a big balance, you may get a much lower interest rate on a 401(k) loan. If you have upcoming debt payments and no other alternatives for paying them, borrowing from your 401(k) can reduce fees and penalties.
A 401(k) loan
While you'll pay interest similar to a more traditional loan, the interest payments go back into your account, so you'll be paying interest to yourself. You can borrow against your 401(k) for a variety of reasons, such as funding the purchase of a house or paying for a dependent's college tuition.
Do hardship loans hurt your credit?
Disadvantages of a credit card hardship program
On the other hand, being in a credit card hardship program may have a temporary negative impact on your credit scores, as participation in these types of programs — as well as any missed payments —can still be reported to the three credit bureaus.
Some of the easiest loans to get approved for if you have bad credit include payday loans, no-credit-check loans, and pawnshop loans. Personal loans with essentially no approval requirements typically charge the highest interest rates and loan fees.
The act itself of signing up for a hardship plan has no effect on your credit. However, once you enroll, your credit scores could be indirectly affected because of the way the program works.
Employers can require proof from the employee of the amount of financial hardship. For example, if you are using a hardship withdrawal to pay your medical bills, your employer may require that you provide those medical bills. To use a hardship withdrawal, you must not have the funds elsewhere to cover the expense.
If the plan does allow hardship distributions, it must specify the criteria that define a hardship, such as paying for medical or funeral expenses. Your employer will ask for specific information and possibly documentation of your hardship.
To make a 401(k) hardship withdrawal, you will need to contact your employer and plan administrator and request the withdrawal. The administrator will likely require you to provide evidence of the hardship, such as medical bills or a notice of eviction.
You may be forced to repay the loan immediately if the lie is discovered. You could face financial hardship if you're approved for a loan you can't afford. You could end up in jail.
The Internal Revenue Service allows a 401(k) hardship withdrawal if you have an "immediate and heavy financial need." In these situations, the 10% penalty could be waived. According to the IRS, the following as situations might qualify for a 401(k) hardship withdrawal: Certain medical expenses. Burial or funeral costs.
Hardship withdrawals are treated as taxable income and may be subject to an additional 10 percent tax (and usually are). So the hardship alone won't let you avoid those taxes.
Acceptable Documentation
Lost Employment. • Unemployment Compensation Statement. (Note: this satisfies the proof of income requirement as well.) • Termination/Furlough letter from Employer. • Pay stub from previous employer with.
What are the pros and cons of hardship withdrawals?
Hardship Withdrawals
A hardship withdrawal could also be useful if you experience an extended period of unemployment and don't have an emergency fund to fall back on. The IRS waives the penalty if you're unemployed and need to purchase health insurance, although you'd still owe taxes on what you withdraw.
A hardship loan provides funds that can help you get by during a difficult financial time. This loan can help bridge an income gap or cover an emergency. Borrowers are typically approved within a day or two and receive funds in less than a week.
The SECURE 2.0 Act of 2022 also made changes to 401(k) plans and individual retirement accounts (IRAs) that you want to be aware of: Starting in 2024, you may be able to withdraw up to $1,000 per year from retirement plans for certain emergencies without paying the 10% penalty.
End the need to take a plan loan before a hardship withdrawal. The new rule removes a requirement that participants first take a plan loan, if available, before making a hardship withdrawal.
While there isn't technically a limit on the number of 401(k) hardship withdrawals you're allowed in a year, you are limited by whether you qualify and whether you have enough money in your 401(k) to cover the qualifying hardship amount.
