I am looking to take a medical hardship withdrawal from my 401(k). Will I face a penalty? My husband and I make around $95,000 a year. It is possible that we will have to withdraw between $10,000 and $11,000. Also, the form asks if I want to take out federal and state taxes. I do, but don't know what percentage to take for each. Can you give me any information on what to be careful of when taking a hardship withdrawal from my 401(k)? If I face a penalty, how much might it be?
Withdrawals from retirement plans are governed by the terms of the actual plan, while the taxation of withdrawals is governed by tax law. Much depends on the plan and its restrictions, your age, your tax bracket, and your state of residence.
Retirement plans may or may not allow for hardship withdrawals, and may or may not allow for hardship loans. If both are allowed, taking a loan is almost always the preferred path since that would not create a tax liability or any penalty.
If the retirement plan is a qualified Roth plan, you may be able to take a distribution without any tax implications depending upon the amount of contributions you have made and the length of time you have been in the plan.
Some plans permit in-service withdrawals if you are over a certain age. This could provide access to funds even if hardship withdrawals or loans are not permitted.
Withdrawals from a traditional retirement plan are taxed at your marginal tax rate. If the $95,000 per year is your gross income, the applicable federal marginal rate would probably be 15 percent. If it is your taxable income, the marginal rate would be 25 percent. In addition, if you are under 59 ½, you would be subject to a penalty of 10 percent of the amount distributed.1
In Pennsylvania, no state tax would be due on a distribution while you are still employed if the amount of your contribution exceeded the amount distributed. Distributions after retirement are not subject to Pennsylvania income tax.
Given so many variables, you should consult with your tax advisor to determine the best approach to take. To find a CPA in Pennsylvania, check with family and friends for recommendations or visit PICPA’s CPA Locator.
1 These numbers are for the year 2014 when the question was originally posted. Changes in tax brackets and rates may affect the calculations as shown if withdrawals are made in other years.
Answer By: Elizabeth Kidd, CPA, is a retired CPA in Erie, Pa.
***Answer originally published June 1, 2014.