401(k)ology – Hardship Distributions – Tapping into Retirement Savings, a Last Resort
By Joni L. Jennings, CPC, CPFA®, NQPC™ | Published May 5, 2025

For many Americans, a 401(k) plan serves as a cornerstone of retirement savings. However, financial emergencies can sometimes force individuals to consider tapping into these funds before retirement. One such option is a hardship distribution—a special type of early withdrawal allowed under specific circumstances. While these distributions can offer immediate relief, they also come with important rules and tax implications that plan sponsors and individuals should understand before a hardship distribution is requested from the company 401(k) plan.
Life can be filled with unexpected events that put a financial strain on the household and family. In recent years, Americans have experienced an increase in natural disasters, from wildfires to tornadoes and hurricanes. Add to that recent market turmoil, job uncertainty, high levels of inflation, and skyrocketing housing costs and there is a recipe for financial strain. Not surprisingly, there has been an increase in the number and amount of hardship requests over the last several months which have prompted questions from our clients about what exactly qualifies.
While 401(k) plans are primarily focused on helping working Americans save toward retirement, most include a last resort option for participants to tap into that savings when there is a heavy and immediate financial burden that they have no others means to pay. Hardship distributions may be available to ease that financial burden but the reason for that distribution of 401(k) funds must meet very specific requirements.
Initially, it might seem like taking a hardship distribution is the easiest solution. However, participants need to be aware that the Internal Revenue Service will take a large portion of the distribution in taxes, and the individual may owe even more when filing their tax return for the year of the hardship withdrawal, which can in some ways compound the overall financial stress despite the short-term relief.
Hardship distributions also impact the plan sponsor because the plan sponsor will either need to collect supporting documentation for the hardship request or accept self-certification from the employee.
In this post, we will review the circumstances that qualify as a hardship distribution, discuss the taxes that may apply to the amount withdrawn and provide an overview of the employer’s responsibility when approving hardship distribution requests.
What is a Hardship Distribution?
A hardship distribution is a premature withdrawal from a 401(k) plan (or 403(b) plan) on account of an “immediate and heavy financial need” and the amount withdrawn may not exceed the amount necessary to satisfy that need. Unlike participant loans from a 401(k) plan, hardship distributions do not have to be repaid. However, they permanently reduce the participant’s account balance and therefore can significantly impact retirement savings.
The Internal Revenue Service (IRS) defines specific criteria that are deemed to constitute an “immediate and heavy” financial hardship (also known as the safe harbor hardship reasons), which include:
Medical expenses for the participant, their spouse, dependents, or primary beneficiaries.
Costs related to the purchase of a principal residence (down payment and closing costs).
Tuition and education-related expenses for post-secondary education for the participant, their spouse, children or a primary beneficiary under the plan.
Payments necessary to prevent eviction or foreclosure from the employee’s principal residence.
Funeral expenses for a parent, spouse, child or dependent.
Certain expenses for the repair of damage to the participant’s principal residence (e.g., due to a natural disaster).
Expenses and losses due to federal disasters declared by the Federal Emergency Management Agency (FEMA), including loss of income by the employee.
The first key component is the “immediate need” meaning that the expense is due currently. For medical expenses, “current” may be recently billed or the amount necessary to obtain medical care. Similarly, tuition expenses can be paid covering up to the next 12 months of college education. The other items listed above require a specific event, but the important thing to note is that bills that have already been paid will not satisfy the “immediate need” prong of the test.
The second component is the distribution can only be made in an amount that will satisfy the heavy financial need, which may be grossed up for taxes (federal, state or local income taxes). For example, if the emergency room visit costs $5,000, the employee may request that it be grossed up by 20% (voluntary withholding at time of distribution) so that the net amount the participant receives to pay the bill is $5,000. In this example, the gross distribution would be $6,250 ($5,000/80%). The participant may not request more than $6,250 because that exceeds the amount needed to satisfy the financial burden.
Practice notes: Employers are not required to offer hardship withdrawals in the company 401(k) plan, so the availability and terms may vary based on the specific 401(k) plan's rules.
Medical Expenses: The regulations define medical care as amounts that would be deductible to the participant under IRC §213(d) without regard to the 7.50% limit applicable to Adjusted Gross Income under IRC §213(a). IRS Publication 502 details what medical expenses qualify, including “the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and for the purpose of affecting any part or function of the body.” Elective or cosmetic surgery do not qualify as an eligible hardship medical expense. The list provided in Publication 502 is lengthy, and there are quite a few items that are deductible that one would not expect.
Tuition, Room, and Board: The payment of tuition and college related expenses generally includes everything from books, boarding and educational fees currently charged by the higher education institution. It does not cover amounts that are already covered through a grant, scholarship or paid from a college 529 account. Note that tuition, room and board do not include student loan repayments, because those payments are related to post-secondary education received in the past. Tuition may also be paid for a “primary beneficiary” which will be covered in detail below.
Payments to Prevent Eviction or Foreclosure: Utility bills or other household expenses often accompany eviction and foreclosure requests. Unfortunately, the hardship distribution amount is limited to the amount that is due to the mortgage company to prevent foreclosure or to the landlord for rent to prevent eviction. Late fees and penalties can be included under either, but the gas or electric bill does not qualify. Escrow shortages are another item that does not qualify under the eviction or foreclosure criteria for a qualified hardship distribution.
Damage to Primary Residence: Similar to medical expenses, the damage to a primary residence must qualify as a casualty deduction under IRC §165 without regard to the 10% limit applicable to Adjusted Gross Income under IRC §165(h)(5). Damage does not include regular wear and tear on the home, rather it must result from catastrophic events such as fire, flood, earthquake, tornado and hurricane. For a detailed information on casualty losses, refer to IRS Publication 547, Casualties, Disasters and Thefts.
Primary Beneficiaries and Dependents
Solely for hardship distributions related to medical expenses, tuition related expenses and funeral expenses, a 401(k) plan may permit the hardship for a primary beneficiary under the plan. Individuals qualify as a primary beneficiary if they are a named beneficiary of the participant and would be eligible for a distribution upon the death of the participant covered by the plan. Note that the plan document must indicate that hardships under these three specific criteria are expanded to cover a primary beneficiary.
In addition, employees may take hardship distributions for medical expenses, tuition related expenses and funerial expenses for a dependent of the participant. “Dependent” in this context is defined by IRC §152 as a “qualifying child” or “qualifying relative” of the individual taxpayer.
A qualifying child:
Must be related to the taxpayer, including adopted children
Must have the same principal residence as the taxpayer for more than half of the year
Must meet the age requirements (under age 19 or under age 24 if full time student or if child is permanently and totally disabled, at any age)
Cannot have provided over 50% of his/her own support for the year
A qualifying relative:
Must be related to the taxpayer, including grandchildren and parents
Must have gross income that is less than the current exemption amount
Must derive over 50% of his/her support from the taxpayer
Cannot be a qualifying child of the taxpayer or any other taxpayer for the year
Individuals seeking hardship distributions for expenses related to a qualifying child or a qualifying relative should consult with a tax professional to confirm that the dependent meets all of the qualifications under the regulations to avoid tax penalties and possible repayment of the ineligible hardship distribution.
Documentation for Hardship Distributions
To qualify for a hardship withdrawal, the employee must demonstrate the immediate need and prove that the amount requested does not exceed the amount due to satisfy the financial burden (though it may include taxes or penalties resulting from the distribution). Additionally, the employee must show that they have no other reasonable means to meet the financial need—this could include showing that all other options have been exhausted. Since 2019, the employee is no longer required to take a participant loan from the plan before being eligible for a hardship distribution; however, plan sponsors may optionally include this requirement in the company’s 401(k) plan.
The substantiation of the hardship can be made by either requiring the employee to provide the source documentation to the Plan Administrator or by allowing the employee to self-certify (referred to by the IRS as the “summary substantiation method” and some vendors as “e-certify”). If the employee provides documentation, the Plan Administrator is responsible for assessing the information provided before approving it to determine if it meets the immediate and heavy financial need test. The plan’s recordkeeper-custodian often handles the self-certification process, taking the document collection task off the plan sponsor’s hands. However, plan auditors may request this information, and employers must make the documentation available if requested by the IRS at the time the employee files their tax return.
Under self-certification, the employee must attest in writing that:
The financial need meets one of the specific hardship distribution reasons;
The amount that is being requested is not in an amount that is in excess of what is required to satisfy the need; and
Certify that they have no other reasonable means to satisfy the hardship.
NOTE: If the plan uses self-certification, the plan should provide participants information on what source documentation to retain in case they are asked to produce the evidence for the hardship. Best practice for plan sponsors electing to utilize self-certification is to provide education and information to the employees on the types of documents that they must retain and produce upon request.
Taxation Rules for Hardship Distributions
Hardship withdrawals from 401(k) accounts are generally subject to ordinary income tax and may also incur an early withdrawal penalty, depending on the age of the participant and the type of contributions withdrawn.
Ordinary Income Tax: The amount withdrawn is added to the individual's taxable income for the year and taxed at their ordinary income tax rate. Voluntary federal withholding may be elected at the time the distribution is made to the participant.
10% Early Withdrawal Penalty: If the participant is under age 59½, a 10% early withdrawal penalty applies. The 10% early withdrawal penalty is assessed at the time the participant files their personal tax return for the calendar year of the distribution. Specific exceptions apply to the 10% early withdrawal penalty, which participants should discuss with their tax advisors.
Hardship distributions are not subject to the mandatory 20% federal withholding that applies to other types of distributions. At the time of the hardship distribution request, the participant may elect voluntary tax withholding (typically 10%) or may elect not to have any taxes withheld. If the participant elects to have no withholding apply to the hardship, the participant will pay ordinary income tax and possibly an additional 10% depending on the age of the participant. That can be a big tax hit, so educating participants about the taxation rules for hardship distributions is important to their overall financial planning.
Roth 401(k) hardship withdrawals are subject to different taxation rules. Qualified Roth withdrawals (after age 59½ and held in the plan for at least five years) are tax-free. Non-qualified Roth hardship withdrawals are taxed only on earnings withdrawn—not contributions—and may be subject to the 10% early withdrawal penalty.
Before initiating a hardship withdrawal, participants should consider all alternatives, such as 401(k) loans or outside financing. Participants should also understand the long-term impact on retirement savings because hardship withdrawals are not repaid to the plan and will therefore permanently reduce their retirement savings.
Consequences of Invalid Hardship Distributions
If the plan mistakenly pays a hardship distribution that does not meet the specific plan and IRS criteria, the employer should correct the overpayment pursuant to the Employee Plans Compliance Resolution System (EPCRS) return of overpayment correction method. Invalid hardships may occur if the distribution did not meet the allowable reasons, the amount exceeded the need, or the participant had other means available to satisfy the immediate and heavy financial burden.
This correction process requires the plan sponsor to:
Notify the participant in writing that the hardship was not valid,
Request that the participant return the funds (plus earnings) to the plan, and
Take any other reasonable actions to have the funds returned.
If the participant does not repay the funds to the plan, no further action by the plan sponsor is needed. However, the plan sponsor should review the policies and procedures in place for reviewing and approving hardship distribution requests to prevent the error from re-occurring.
Conclusion
Hardship distributions from a 401(k) can provide critical financial support in times of genuine need, but they come at a cost. Taxation and potential penalties can significantly reduce the amount received, and the long-term consequences to retirement savings can be substantial. It’s essential for employees to carefully evaluate the need, explore other options, and understand all tax implications before moving forward with a hardship withdrawal.
Newfront Retirement Services’ team of advisors and dedicated service team are always available to help plan sponsors assess hardship requests or aid in setting up self-certification. Feel free to contact me or just connect to keep up to date on all things ERISA 401(k): Joni_LinkedIn and 401(k)ology
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Joni L. Jennings, CPC, CPFA®, NQPC™
Chief Compliance Officer, Newfront Retirement Services, Inc.
Joni Jennings, CPC, CPFA®, NQPC™ is Newfront Retirement Services, Inc. Chief Compliance Officer. Her 30 years of ERISA compliance experience expands value to sponsors of qualified retirement plans by offering compliance support to our team of advisors and valued clients. She specializes in IRS/DOL plan corrections for 401(k) plans, plan documents and plan design.