Hardship withdrawal requests up after Sandy

(MoneyWatch) In the wake of Superstorm Sandy, some employers are reporting an increase in workers requesting withdrawals from the retirement plans.

Unlike after Hurricane Katrina, the IRS has not yet announced special tax relief that would make such withdrawals less costly in regards to taxes and penalties, but this is a possibility. Folks affected by Sandy should also contact the Federal Emergency Management Agency (FEMA) to apply for assistance.

Before taking a hardship withdrawal from your employer's retirement plan, you need to know that these special withdrawals are different from loans. Hardship withdrawals are taxable and include a 10 percent penalty for early withdrawal. Hardship withdrawals, which are available in many 401(k) plans, allow individuals in certain situations to take a distribution from their 401(k) or other retirement plan accounts while they are still working for the employer that sponsors the plan.

Generally, hardship withdrawals may be taken only if there is an immediate and heavy financial need, the withdrawal is necessary and you cannot get the money needed from any other reasonable source. According to IRS rules, hardship withdrawals are only permitted for specific reasons, which include:

Qualified medical expenses that exceed 7.5 percent of adjusted gross income,

Purchase of a primary residence

Payment of qualified tuition expenses

Funeral or burial expenses,

Home repair expenses due to casualty losses, and

To prevent eviction or foreclosure of a mortgage on a primary residence.

While the reasons for taking such withdrawals are urgent and unfortunate, before you do it you need to know that there are several downsides when taking hardship withdrawals from a retirement plan. The amounts distributed are taxed as ordinary income and if the individual is under age 59 and 1/2, an additional 10 percent penalty will apply to the amount withdrawn. Most employers' 401(k) plans bar employees from making contributions for six months after taking a hardship withdrawal.

Another downside is that an amount taken as a hardship withdrawal cannot be repaid to your 401(k) account, so doing this permanently reduces the balance of your retirement savings. Also, many employers require you to provide a written explanation of the reason for requesting a hardship withdrawal and why the need cannot be satisfied from other reasonable resources. Revealing private details to your employer can be awkward.

Ray Martin

View all articles by Ray Martin on CBS MoneyWatch»
Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.

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