The main benefit of a 401(k) hardship withdrawal is the amount of money it provides to meet genuine emergencies, reports Bankrate. Additionally, a number of hardship situations qualify for exceptions to penalties. Disadvantages include a penalty tax on nonqualifying withdrawals and a reduction of investment funds in the account.Continue Reading
Nonqualifying hardship withdrawals that 401(k) account owners take before they are 59 1/2 years old incur a 10 percent penalty tax as well as regular income tax, explains the Internal Revenue Service. Qualifying exceptions include distributions after the complete disability of the account holder, to pay medical expenses that total over 10 percent of adjusted gross income, to pay tax bills owed to the IRS, and for military reservists called to active duty for 180 days or more. Account owners can also avoid the tax penalty by arranging the distribution in a series of substantially equal periodic payments that must continue for five years or more, or until the account owner turns 59 1/2.
Although expenses such as the purchase of a primary residence, repairs of damage to a residence, payment of secondary education expenses and funeral expenses qualify as hardship withdrawals, they are subject to the penalty tax, states the IRS. Additionally, the reduced amount of money available for investments after withdrawals slows the growth of the retirement fund, cautions U.S. News & World Report. This can have long-term consequences on the age when the account holder can retire and the lifestyle he is able to afford.Learn more about Financial Planning