Hardship Distributions


401(k) plans are tax-favored plans that must be set up with the purpose of assisting participants save for retirement. Retirement plans are not savings accounts where contributions can be added or taken away whenever the account holder wishes. In general, once money is set aside in a 401(k) plan, the idea is that it is not withdrawn/used until retirement. A few exceptions exist to this general rule. For example, a plan may allow participants to receive a distribution of their retirement savings if they have experienced a hardship.

Hardship distributions can only be permitted if the plan document provides for hardship distributions. How hardship is defined and which accounts can be withdrawn from will also depend on the plan’s rules. Note that just because a distribution is allowed does not mean it is encouraged. Depending upon the age of the participant, the distribution may be subject to additional tax penalties.

Loans and Hardship

Plans considering offering hardship distributions should also consider whether the plan currently offers or wants to offer plan loans. The hardship option is dependent upon the plan’s loan options. Before a participant can obtain a hardship, typically the employee must have exhausted all other plan distributions or loans. If your plan does not offer loans, then hardships are the only option for participants not otherwise eligible to take a plan distribution. Hardships cannot be re-contributed to the plan, while loans are typically automatically recontributed to the plan by payroll deduction. Offering both options (hardships and loans) will increase the administrative burdens on the plan administrator.

Other Distributions Before Retirement Age

Typically, 401(k) plans will allow at least a few distributions prior to retirement age. Note that none of these distribution options are required – a plan could restrict distributions until the participant reaches retirement age (typically age 65). Pre-retirement distributions from a 401(k) plan could include distributions upon termination of employment and/or upon attainment of a certain age and/or service. 401(k) contributions can be distributed upon attainment of age 59 and ½. Prior to age 59 and ½, a participant’s only options to access their 40(k) contributions include loans, hardship or upon termination of employment. All of these options will always depend on the terms of the plan.

What is a Hardship?

While there is some flexibility in how plans can set up hardship distributions, most plans follow the 401(k) “safe harbor” hardship rules. The safe harbor hardship rules are somewhat restrictive. However, using the safe harbor rules will mean the employer does not need to determine when an employee is experiencing a hardship according to a fact and circumstances test. Many employers would prefer to refrain from inquiry into their employee’s financial circumstances.

Safe harbor hardship distributions have two requirements:

  1. There must be one of 6 recognized hardships:
    1. Medical care expenses for the employee, or the employee's spouse, children, dependents or beneficiaries;
    2. Tuition, related educational fees, and room and board expenses, for up to the next 12 months of post-secondary education for the employee, or the employee's spouse, children, dependents or beneficiaries;
    3. Burial or funeral expenses for the employee's deceased parent, spouse, children, dependents or beneficiaries;
    4. Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
    5. Payments necessary to prevent the eviction of the employee from the employee's principal residence or foreclosure on the mortgage on that residence; or
    6. Certain expenses for the repair of damage to the employee's principal residence.
  2. The hardship distribution must be necessary to satisfy the financial need. Under the safe harbor rules, this requirement is met if all of the following apply:
    1. The distribution is not greater than the amount of the immediate and heavy financial need, including the amounts necessary to pay any taxes resulting from the distribution;
    2. The employee has obtained all other distributions and loans available under the employer’s plans; and
    3. The employee is not allowed to make elective deferrals to the plan for at least six months after the hardship distribution.

Note that expenses related to maintaining a home or residence are restricted to the home/residence of the employee and do not include home/residence of family. Medical expenses, tuition and burial expenses can be for the employee, or the employee's spouse, children, dependents or beneficiaries. Plans can also restrict hardships for medical expenses, tuition and burial expenses to the employee, the employee's spouse, children, or dependents and exclude expenses of beneficiaries.

As stated above, hardship distributions are dependent upon the plan’s loan program. Loans must be exhausted first before a hardship distribution can be made. In addition, the hardship distribution has a timing requirement that must be tracked – no elective deferrals for 6 months. For example, systems must be in place so that if a person who has received a hardship distribution turns in a new deferral election prior to the expiration of 6 months, her election is not put into effect until the 6-month period has expired.

Which Accounts can be Distributed?

Determining whether your plan allows for hardship and the terms of the hardship are the first steps. Just as important is making sure hardships are distributed only from permitted accounts. Certain employer contribution accounts cannot be distributed upon a hardship. The plan can also further limit hardship distributions to certain accounts. Most commonly, plans will restrict hardship distributions to elective deferral (401(k)) accounts only – restricting hardships to funds that employees have elected to defer from their salary.

Proof of the Need

Generally, the same information used to show the amount of the need is also proof of the financial need (a tuition bill, a medical bill, etc.). Under the safe harbor hardship rules, the plan sponsor need not and should not determine the employee’s overall financial situation. The plan document and its policies and procedures should set forth the process for the plan administrator to follow. Don’t let personal bias get in the way of making a proper determination. On the other hand, if you are concerned about actual fraud, the plan administrator likely has a duty to investigate and ensure plan assets are not being distributed under fraudulent circumstances.

Making a Hardship Determination

A hardship determination will typically resemble the following:

  1. Does the plan allow hardship distributions?
  2. Does the hardship of the employee meet a type of hardship permitted by the plan?
  3. Is the distribution requested equal to or less than the financial need shown by the employee (including taxes the employee must pay)?
  4. Has the employee obtained all other distributions and loans available under the employer’s plans? (If the employer sponsors other plans, ensure those plans are also considered.)

If you can respond affirmatively to all of the above, ensure:

  1. the plan has processes and procedures in place to prevent the employee from making elective deferrals for the next 6 months (or longer period that may be specified in the plan);
  2. hardship distributions are made only from accounts permitted under the plan; and
  3. keep records of the proof of the hardship with other retirement plan records.

Tax Consequences

Distributions from a retirement plan are generally subject to income tax no matter when the distribution is made (assuming the contributions are pre-tax contributions and not Roth contributions). However, an additional 10% tax can apply to early distributions from a retirement plan – even if the distribution is permitted under the plan’s rules. If the participant is at least age 59 and ½, the early distribution tax will not apply. If a participant is not 59 and ½, the distribution will need to meet an exception to the early distribution penalty. Some exceptions include first-time home purchases, medical expenses and higher education expenses. Note that these exceptions often have dollar limitations and do not overlap with all the hardship distribution options. For example, a plan could allow for a hardship distribution in order to purchase a principal residence but if it is not a first-time home purchase, it could be subject to the early withdrawal 10% penalty (assuming the employee is younger than 59 and 1/2). Employees should seek assistance from their tax advisor on how any withdrawal will affect their tax liability.


Offering hardship distributions to participants helps ensure they can access funds in time of need. However, before implementing a hardship program, the plan administrator must be prepared to monitor and administer the program – ensuring the 6-month limitation on elective deferrals is followed, records are maintained, and distributions are made accurately. Hardship programs can also require making uncomfortable decisions that will affect the lives of employees about their own money. Setting up a loan program may be an alternative to having to make determinations of whether an employee’s situation meets the hardship criteria.