Hardship Withdrawal vs. Distribution

by Mark Kennan

Not all money taken out of retirement plans goes toward retirement expenses. In certain situations, you can get money out early depending on the type of retirement plan. Knowing the difference between taking a hardship withdrawal and a qualified distribution can save you money on your income taxes.

Qualified Distributions Defined

Tax-deferred retirement plans require you to be at least 59 1/2 years old before taking a qualified distribution from the account. Roth accounts, such as Roth IRAs, Roth 401(k)s and Roth 403(b)s, require that you have maintained your account for at least five years. As long as you satisfy these conditions, you can remove the money from your retirement plan without providing documentation of a hardship, or having to pay extra penalties upon withdrawal.

Employer Plan Hardship Withdrawals

Hardship withdrawals are treated differently depending on whether you have an employer plan, such as a 401(k) or 403(b), or an IRA. With an employer plan, you can only take money out of the account before age 59 1/2 if you leave the company, or have a severe financial burden that you cannot satisfy with other funds. Even then, the plan must permit hardship distributions and you can still be required to pay an early withdrawal penalty. Like IRAs, employer plans waive the penalty in cases of medical expenses exceeding 7.5 percent of your adjusted gross income and permanent disability. You can also avoid the penalty on an employer plan hardship withdrawal for a qualified domestic relations order.

IRA Hardship Withdrawals

With an IRA, you can take money out early from your account for any reason you want. This freedom to remove money at any time is drastically different from employer plans. However, unless you meet one of the exceptions, you have to pay an early withdrawal penalty. In addition to the exceptions for certain medical expenses, IRAs also waive the penalty for college costs and first-time home buyer expenses (limit $10,000).

Tax Treatment

When you take a hardship withdrawal, you have to pay a 10 percent penalty on the taxable portion of the distribution on top of your income taxes, unless you have an exception. If you do have an exception, you still have to pay the income taxes. However, if you take an early withdrawal from a Roth IRA, your contributions come out without being taxed. When you take qualified distributions, you owe no penalties, only any applicable taxes. With tax-deferred retirement plans, the entire amount is taxable. With Roth plans, the entire amount comes out tax free.

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