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You know the times are tough when people are robbing money from their 401(k) accounts early and using the hardship withdrawal rules to give them access to needed cash. The lingering high unemployment rate and slew of home foreclosures have been major factors. Companies with retirement plans are reporting a rise in the number of workers who are withdrawing money early.

I read nearly 7% of 401k account holders made a withdrawal and about 20 percent of the withdrawals were for hardships. Just to put that in perspective, before the 2008 economic downturn, about 5 percent of workers withdrew money from their account each year. There has been an increase in hardship withdrawals in the past two years and the most frequently cited reason for hardship withdrawals last year was to avoid a home eviction or foreclosure. The lender are on track to take back around 800,000 homes this year. Even though that is down from last years numbers of around one million, that is still a painfully high number.

Most people who make withdrawals under hardship have to pay taxes and a 10 percent penalty on the money taken out which can be expensive and therefore it should be viewed as a last resort. I think is is normal for someone to want to save their home and avoid foreclosure BUT most of the time these delay tactics only result in a temporary delay and end up in foreclosure. This is a poor use of the retirement money you now, even more so, desperately need. Removing money from a retirement account permanently reduces the savings and diminishes what it can earn over time. If you are in such a situation, you really need to talk to an experienced professional who understands the 401k rules and foreclosure and bankruptcy laws as well.

The Internal Revenue Service makes it clear the worker must have exhausted other financial resources first before taking a hardship withdrawal. That includes bank loans and tapping the assets of a spouse. Workers must also have already exhausted any other distribution and loan possibility with their employer’s retirement plan. The IRS classifies six expenses as hardships and most plans follow these guidelines. They include certain medical expenses, the cost of buying a family’s principal home, college costs, payments necessary to avoid eviction or foreclosure, burial expenses, and certain expenses for the repair of damage to the employee’s principal residence. Of course, the IRS has made exceptions on occasion to some of the hardship withdrawal rules. For example, victims of some hurricanes have been given a break. So if you have experienced a natural disaster you should inquire about whether there’s an exception for your situation.

The process is that an employee will need to contact the person in his company responsible for managing the 401k program. There will be an application process during which the worker will have to demonstrate the hardship. The worker also will need to demonstrate that other borrowing and resources have been tapped and the withdrawal is the last resort.

One thing to thing about is that once that money is taken out you will no longer experience that money working for you over time. It is a lost opportunity for example if the market starts to skyrocket and your money is no longer in the game. Many times you will be prohibited from contributing more money to the account for six months after taking the withdrawal which only hurts you further. A 401(k) loan should only be used as a temporary stop gap to get help in tough financial times and when you feel like you have some job security because a high percentage of workers with loans who lose their jobs default on the loan. Remember, it should be noted that a 401(k) loan is usually due within 60 days of job termination and when it’s not repaid, the money is treated as an early withdrawal and taxes and the 10 percent penalty must be paid.

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