7.19 Withdrawals From 401(k) Plans Restricted

By law, you may not withdraw funds attributable to elective salary-reduction contributions to a 401(k) plan unless (1) you no longer work for the employer maintaining the plan; (2) you have reached age 59½; (3) you have become totally disabled; (4) you can show financial hardship; (5) you are eligible for a qualified reservist distribution (7.15); (6) you are the beneficiary of a deceased employee; or (7) the plan is terminated and no successor defined contribution plan (other than an employee stock ownership plan) is maintained by the employer. If a distribution is allowed and all of your plan contributions were pre-tax elective salary deferrals, the entire distribution is taxable unless it is rolled over to an eligible plan (7.7).

Under IRS rules, it is difficult to qualify for hardship withdrawals; see below. If you do qualify, the withdrawal is taxable, and if you are under age 59½, it is subject to the 10% early distribution penalty unless you meet a penalty exception (7.15).

The hardship provision and age 59½ withdrawal allowance do not apply to certain “pre-ERISA” money purchase pension plans (in existence June 27, 1974).

An “involuntary” distribution resulting from an IRS levy on a 401(k) plan account is taxable to the employee (assuming only “pre-tax” contributions) but is not subject to the 10% penalty on pre-age 59½ distributions (7.15).

Withdrawals before age 59½.

Withdrawals for medical disability, financial hardship, or separation from service are subject to the 10% penalty for early distributions unless you meet one of the exceptions (7.15).

Loans.

If you are allowed to borrow from the plan, loan restrictions (7.16) apply.

Qualifying for hardship withdrawals.

IRS regulations restrict hardship withdrawals of pre-tax salary deferrals. If you qualify under the following restrictive rules you may withdraw your elective deferrals. Income allocable to elective deferrals may be withdrawn as part of a hardship distribution only in limited circumstances. If the plan so provides, income may be withdrawn if it was credited to your account by a cut-off date that is no later than the end of the last plan year ending before July 1, 1989.

Planning Reminder

Hardship Distribution Not Subject to Withholding

A hardship distribution from a 401(k) plan is not eligible for rollover (7.7) to an IRA or an eligible employer plan. Your employer will not apply 20% withholding to the distribution, as mandatory withholding applies only to rollover-eligible distributions (7.7).

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The IRS requires you to show an immediate and heavy financial need that cannot be met with other resources.

Financial need includes the following expenses (this list may be expanded by the IRS in rulings):

• Purchase of a principal residence for yourself (but not mortgage payments);
• Tuition, related fees and room and board for the next 12 months of post-secondary education for yourself, your spouse, children, or other dependents;
• Medical expenses previously incurred for yourself, your spouse, or dependents or expenses incurred to obtain medical care for such persons;
• Preventing your eviction or mortgage foreclosure; and
• Paying funeral expenses for a family member.

Even if you can show financial need, you may not make a hardship withdrawal if you have other resources to pay the expenses. You do not have to provide your employer with a detailed financial statement, but you must state to your employer that you cannot pay the expenses with: compensation, insurance, or reimbursements; liquidation of your assets without causing yourself hardship by virtue of the liquidation; stopping your contributions, including salary deferrals, to the plan; other distributions or nontaxable loans from plans of any employer; or borrowing from a commercial lender. Your spouse’s assets, as well as those of your minor children, are considered to be yours unless you show that they are not available to you. For example, property held in trust for a child or under the Uniform Transfers (or Gifts) to Minors Act is not treated as your property.

Under a special rule, you are considered to lack other resources if you have taken all available distributions from all plans of the employer, including nontaxable loans, and you suspend making any contributions to any of the employer’s qualified and nonqualified deferred compensation plans for at least six months after receipt of the hardship distribution. Furthermore, all of the employer’s plans must provide that for the year after the year of the hardship distribution, elective contributions must be limited to the excess of the annual salary deferral limitation over the elective contributions made for the year of the hardship distribution.