Retirement Plan Loan Alternative

Valuable Information on 401ks, Pensions, ESOPs, Form 5500 Preparation + More

Many retirement plan participants may already know about the option to take out a loan against their retirement account. What you may not know about is the option to take out a hardship (though, all plans may not offer the option). A hardship, as defined by the Internal Revenue Service (“IRS”), “must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need”. In addition, there are certain “safe harbor” instances in which the IRS regulations have automatically determined an immediate and heavy financial need exists. They are:

  • Certain medical expenses
  • Costs related to purchasing a principal residence
  • Tuition and related educational fees and expenses
  • Payment to prevent the eviction from or foreclosure on a principal residence
  • Burial or funeral expenses
  • Certain expenses to repair damages to a principal residence

Outside of the examples above, a hardship is able to be taken if a participant can document their immediate and heavy financial need.

Once a hardship distribution is taken, the employee will typically not be allowed to make contributions to their plan for a minimum of six months. A hardship is not required to be paid back and will permanently decrease the balance of the employee’s retirement account.

When to take a hardship versus a loan

A hardship distribution is typically seen as a last resort. Many plans require that you take out all possible loans before the hardship distribution will be granted. However, if the loan will cause additional harm, then the employee may be able to take the hardship without the loan first. Examples of this can be if the loan repayments are to put the employee in further financial stress; or, in the case of purchasing a primary residence, the loan could prevent the employee from obtaining additional financing.

As with loans, each plan will have different requirements. This blog does not cover every situation and you should go to your plan administrator or human resources personnel for specialized information.

By Alyssa Borrego