I have an employee that took out a $25k hardship withdrawal. He has not cashed the check yet; however, he found out he does not need as much as he originally thought. Is he able to A) cash the check and return a portion back to the plan B) return the entire uncashed check and take out a lesser amount of hardship? I am unsure on the rules on this. I thought at one point I saw there was a set number of days that the funds could be returned without tax or penalty. Thank you!
Having received the check, the employee is in constructive receipt of the distribution. A hardship distribution is not eligible for rollover, so there is nothing the employee can do but cash the check, include the entire amount in income and pay the tax and 10% early-distribution penalty. Since the employee has excess funds, the employee could potentially increase 401(k) deferrals for some time, but there is little time left in 2023 to do that to reduce taxable income on their W-2. If their modified AGI for the purpose permits, the employee could also potentially make a deductible traditional IRA contribution to reduce 2023 taxable income. Neither of these would avoid including the hardship distribution in 2023 income and paying the 10% early-distribution penalty.
In general, a withdrawal may be returned within 60 days. Or, the employee can deposit part of the withdrawal in a private IRA within 60 days and call it a rollover, which would be non-taxable.
Thank you so much. Is he able to cash the check and return a portion within 60 days to avoid the tax/penalty?
Having received the check, the employee is in constructive receipt of the distribution. A hardship distribution is not eligible for rollover, so there is nothing the employee can do but cash the check, include the entire amount in income and pay the tax and 10% early-distribution penalty. Since the employee has excess funds, the employee could potentially increase 401(k) deferrals for some time, but there is little time left in 2023 to do that to reduce taxable income on their W-2. If their modified AGI for the purpose permits, the employee could also potentially make a deductible traditional IRA contribution to reduce 2023 taxable income. Neither of these would avoid including the hardship distribution in 2023 income and paying the 10% early-distribution penalty.
@angeladeets wrote:
Thank you so much. Is he able to cash the check and return a portion within 60 days to avoid the tax/penalty?
I apologize. While I said "in general", hardship withdrawals can't be rolled over. I suppose that you don't really have an immediate financial hardship if you are just rolling the money over to a different investment.
At best, the entire amount has to be returned, and then the employee could request a smaller amount. At worst, the employee is stuck with what they requested. I will try to find out more, but we can also wait for @dmertz who is our definitive authority on this forum.
Regarding increasing 401(k) deferrals, I think it used to be that deferrals had to stop for a period of time if a hardship distribution was made, but I think the tax code was changed sometime in the past few years to allow deferrals to continue [Edit: Or maybe I'm just thinking of a common feature of 401(k) plan agreements]. Still, the plan agreement would dictate.
@dmertz wrote:
Regarding increasing 401(k) deferrals, I think it used to be that deferrals had to stop for a period of time if a hardship distribution was made, but I think the tax code was changed sometime in the past few years to allow deferrals to continue. Still, the plan agreement would dictate.
Yes, I did find that while I was researching the issue (and found my own mistake). There used to be a rule that you could not make elective contributions for 6 months after a hardship withdrawal, but that was eliminated.