Hardship Loans v. Hardship Distributions

Many employees are tapping into their 401k plan accounts to make ends meet during these challenging times. Recent data available show an undeniable uptick in distributions when employees leave their companies, loans when they are employed, and hardship distributions when they are still employed but experiencing a financial hardship. With respect to the hardship distributions, some companies’ plans have adopted a hybrid type of assistance called a hardship loan.

TImes are Hard, Give me my Money

Most 401k plans have provisions that allow employees to take have access to their 401k accounts when they are still employed either through Loans or Hardship Distributions. Loans are the most common way employees access their money. 401k Plan Loans work like other loans you might get from a bank in that they are for a specific term (usually 5 years), carry a set interest rate, and require mostly equal, periodic repayment, this occurs through payroll for employees.

Hardship Distributions are very different from Loans. A Hardship Distribution can only be made to an employee under very specific circumstances, does not get repaid, and the amount distributed is subject to ordinary income tax as well as a 10% penalty if the employee is under 59 1/2.

What is a Hardship?

A “Hardship” is a very specific set of circumstances as determined by the IRS. Hardships include: Purchase of a home, Higher Education expenses for a dependent, prevention of eviction from your home, severe financial hardship, and tax deductible medical expenses not otherwise reimbursed. That’s it.

Now what is interesting about loans and hardships is that your company’s 401k plan is not required to permit either. These are optional features of the plan. As a consequence, your employer may only have loans, or hardships, or even a combination of the two.

Hardship Loans

Some employers will only permit loans if the loan is for a hardship, thereby requiring the employee to prove a legitimate hardship before getting a loan. Why would an employer do this? I have no idea, but it is his right. Moreover, if the plan only permits loans for hardships than the loan program must be administered properly or the plan could risk getting disqualified by the IRS.

A group of employees at QVC, allegedly, applied for Hardship Loans without having actual hardships verified and as of last week, now find themselves in hot water with the company. The point of this is know how your company’s programs work. If as a place of last resort, you need money from the plan make sure you comply with the rules so that you don’t end up in an uncomfortable situation with your employer.

Source: http://rolloverusa.com/2009/08/hardship-loans-v-hardship-distributions/

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