Difference Between Hardship Withdrawal and 401(K) Loan

If you are facing financial hardship but have accrued money in a 401(k), you may have options to help in a crisis. These include taking out a 401(k) loan or a hardship withdrawal.

You usually are not allowed to withdraw money from retirement accounts without paying harsh penalties, but if you face a hardship, you may qualify for these options. Usually, a 401(k) loan is easier to get than a hardship withdrawal, but the latter option might be necessary.

401(k) loans

When you take out a 401(k) loan, you essentially borrow money from yourself. If you’ve lost your job and need help to cover rent, medical expenses, or pay for other necessities, then you can use this type of loan to cover those items. However, you will need to pay back the money you take.

You must also follow IRS requirements. These are:

Your application must go through the administrator for your plan

The limit for the loan is the lesser of either 50% of your vested balance or $50,0000.

The loan must be repaid within five years, with payment made quarterly

You can borrow multiple loans as long as they collectively add up to less than the limits outlined by the IRS.

There are exceptions to the final rule. These exceptions are:

The loan is being used to buy a primary home

You are an active-duty military

You are taking up to a year’s leave of absence

Hardship withdrawals

If you are in urgent need, you can make a hardship withdrawal from your 401(k) account under certain conditions. It would help if you waited until you were 59.5 years old. Otherwise, you will incur a 10% penalty. 

However, when you make a hardship withdrawal, you are not charged this fee, though you still will have to pay taxes. Repayment is not required.

The IRS rules for a hardship withdrawal are:

You must demonstrate that you have an immediate and severe financial need.

You can only take out the amount needed.

Your employer makes the final decision on whether you qualify.

The IRS, however, gives an automatic “yes” to your withdrawal for one of the following:

Medical expenses. These can be for yourself, your spouse, or your dependents.

Closing costs for your primary residence.

Payments to prevent foreclosure or eviction

Funeral expenses for yourself, spouse, or dependents

College expenses for you, a spouse, or dependents

Substantial property damage to your home

If you need a hardship withdrawal, keep good records, including receipts, to prove that you only took out what was needed. To find out more about hardship personal loans check out Lantern by SoFi. It is an online marketplace that provides information to those looking for loans.

The site also has many informational articles. For example, it allows you to find hardship loans and research credit unions, banks, and online lenders. Lantern by SoFi makes it easier to find and compare interest rates and fees and makes it more accessible for users to apply.

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