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THE RISE IN
mortgage rates, minimum payments on credit cards, and
the cost of living could have plan participants looking
to their 401(k) plan savings for some relief. But what
looks to be a quick fix can leave participants broke in
their retirement years.
Here’s a look at what the definition of financial
hardship is and what it ends up costing participants who
are considering this as an option to relieve some
financial problems.
What Constitutes Hardship?
The IRS code governing 401(k) plans helps protect
participants from themselves by stipulating when and for
what an early withdrawal is permissible. For example,
the IRS considers a participant to be hard-up only when:
- There’s an immediate and heavy financial need;
- There's no other means to pay for this need;
- The withdrawal amount requested doesn’t exceed
the amount
needed; and
- All possible alternatives have been exhausted.
Even so, a hardship withdrawal can only be taken to:
- Purchase a primary residence for the
participant;
- Prevent foreclosure or eviction from a principle
residence;
- Pay college tuition and related expenses due
within 12
months for the participant, a spouse, dependents or children
who are no longer dependents;
- Cover un-reimbursed medical expenses for the
participant, a
spouse or a dependent;
- Pay for funeral expenses; or
- Make repairs on a primary residence.
And the amount requested may not exceed contributions
made by the participant.
The Hard Costs
Hardship withdrawals come at a cost. If the participant
is not yet 59½-years-old, the IRS collects a 10% early
withdrawal penalty, except when the participant:
- Becomes totally disabled;
- Owes medical expenses that exceed 7.5% of the
participant’s
adjusted gross income;
- Gives the money to a divorced spouse or children
by order of
a court;
- Ends employment in the year the participant
turns 55 or is
older (whether through a permanent layoff, termination or
resignation/retirement); or
- Separates from employment with a payment
schedule in place
for withdrawing substantial, equal amounts over the course
of the participant’s life expectancy.
Whether there is a penalty or not, one cost is certain:
a withdrawal counts as income. The participant is liable
for the federal income taxes, as well as state and local
taxes where required, on the amount withdrawn. And, when
this puts the participant in a higher tax bracket, the
benefit is often nearly negated.
The point is: A $10,000 hardship withdrawal does not
increase pocket money by $10,000. In fact, it’s not
unusual for the participant to end up with only about
half of what they withdrew—and that’s the costs they
may readily see.
Hidden Costs: The Other Side Effect
Then there are the costs that a participant typically
doesn’t see. Government regulations forbid a participant
from making plan contributions for six months following
a hardship withdrawal, costing the participant the tax
advantages that come with making these contributions as
well as any employer matching funds. That money is
lost—forever.
Participants also lose the benefit of compounding
interest. Take a 30-year-old participant who begins
contributing $5,000 to a 401(k) plan annually and then
takes a $10,000 hardship withdrawal at age 40. Assuming
an average 8% annual return, the participant would have
$793,094 at age 65. Without the hardship withdrawal,
this total would be $861,584. The $10,000 hardship
withdrawal cost the participant $68,490 in retirement
savings—plus any employer matching funds and interest.
Knowing the government regulations and the real costs
associated with hardship withdrawals can help
participants seek alternative solutions that do not
compromise their future financial well being.
For more information on retirement planning, please visit
http://www.ta-retirement.com/Portal/po_content_viewer.aspx?UserType=R&id=554
or call Transamerica Retirement Services at
888-401-5826.
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