Withdrawing from my 401k

[Amaracotta]

I left my old job June 2021 and had a 401k with Vanguard. My current employer doesn’t match and I haven’t done anything with the account since I left my old company.

I have credit card debt that gives me stress everyday and I’d really like to withdrawal from my 401k to help me pay some of that down and relieve some of my stress. 

My questions are:

could this be considered a hardship withdrawal? 
If i do have to pay the 10% penalty, when do I pay that? and is the 10% or the total amount or 10% after tax? 

thank you! 

[Rangers44]

Great question Amaracotta!

Unfortunately, paying down credit card debt is not an allowable exception to paying a 10% penalty on early distributions, as long as you are under the age of 59 1/2 on the day of withhdrawal.

Read further:

https://www.schwab.com/learn/story/how-does-secure-act-impact-saving-after-age-70

Secondly, what you have to consider is that the amount to withhdrawn is considered taxable income.

That is unknown factor when considering what tax bracket you will be in as of the last day of the year.

At a minimum, you would be required by the financial institution to withhold a minimum of 10% to 20% as backup withholding tax, but that will not mean you have withheld enough to cover your total taxable income of all amounts by December 31st.

Assume the possibility of withholding anywhere from 10% to 20%, just for any income tax as a minimum requirement, and an additional 10% to cover the amount you could owe in penalties, only if you are under 59 1/2.

[AR_CPA]

Hello Amaracotta, 

Hope you're doing well!

Not all plans 401k plans allow for hardship withdrawals. That's up to your employer's discretion. However, even if your 401k plan does allow for hardship withdrawals, credit card debt usually doesn't qualify as a reason to make the withdrawal under hardship rules.  The IRS outlines specific reasons you can make a hardship withdrawal:

1. Paying for certain medical expenses
2. Costs related to buying a home as your primary residence
3. Tuition, related educational fees, and education expenses
4. To cover payments necessary to prevent eviction or foreclosure on your primary residence
5. Burial and funeral expenses
6. Expenses related to repairing damage on your home, including following a natural disaster
7. Birth and adoption costs (up to $5,000)

So, in most cases, you can’t use a 401k hardship withdrawal just because you want to pay off your credit card balances. In this case, you’d be required to take out a 401k loan.

What is a 401k loan?

401k loans have specific terms and conditions as outlined by the IRS.^[2]

• They always have a term of 5 years
• Payments must be made at least quarterly
• The maximum loan amount is 50 percent of your vested account balance OR $50,000, whichever is less
• The loan will have an interest rate, so you will need to repay the money you took out plus interest
• If you leave your job with the company that you have your 401k through, they may require you to pay the full outstanding balance

In general, the money you take out of your 401k is tax exempt. This includes money taken out through a 401k loan. However, if you leave the company, then the money from the loan would be considered as a distribution from the IRS. In this case, you’d also face an immediate tax penalty .

So in your situation, the money you take out of that 401(k) will be taxed as well as you will face a 10% penalty on the amount of distribution.