If you are looking for a way to get out of a financial emergency, you may consider withdrawing money from your 401(k) account. However, if you are below the required retirement age, you may not be allowed to take a distribution from your 401(k) account. However, one exemption to this rule is a hardship withdrawal. You can take a hardship withdrawal to meet an immediate financial need such as medical expenses, home repair after a natural disaster, or to avoid foreclosure on your home.
When you request a hardship withdrawal, it can take 7 to 10 days on average to receive the money. Usually, your 401(k) money is tied up in mutual funds, and the custodian must sell your share percentage of securities held in these investments. Once sold, the plan administrator can take one to three business days to issue a check or make a direct deposit to your bank account.
401(k) Plan Time Frame for Holdings
When you contribute to a 401(k) plan, your money is invested in different types of portfolios comprising mutual funds, bonds, and stocks. If you decide to cash out, you must submit a request to sell your shares before the close of the market at 4 pm EST. Late requests submitted after the close of the market are not considered until the next business day when markets close.
When the plan sponsor receives the request to sell your share percentage of holdings, the shares will be sold and the proceeds transferred to the account custodian. The Federal law provides that 401(k) plans cannot take longer than three business days to disburse 401(k) the money. However, the time frame may vary across different custodians. When requesting a 401(k) withdrawal, you should confirm with the plan sponsor to know how long it will take to receive the money.
What is the T+3 Rule?
The T+3 rule is a settlement cycle that requires security transactions to be completed within three days. When you sell stocks, the plan sponsor must deliver the securities to the broker within three days. In this case, when you request to withdraw money from your 401(k) plan, the plan sponsor must deliver the shares to a brokerage and receive sale proceeds in three days after the trade is executed.
For example, if you request to sell the shares on Friday after 4 PM, Saturday and Sunday will not count. Instead, you consider business days when the market is open. In this case, you will start counting from Monday. If the settlement period is three days, the plan sponsor must receive the payment by the close of market on Wednesday.
The three-day settlement period applies to most securities such as stocks, bonds, and mutual funds that are traded through a brokerage. Usually, this settlement period applies to investors who hold securities in certificate form, and the certificate would have to change hands in the event of a sale or purchase. It also applies to stocks held electronically, but it is unlikely they will face settlement issues.
Vesting implications on 401(k) hardship withdrawals
If your employer offers a 401(k) match, the match can increase the value of your 401(k) assets exponentially. However, the employer’s contributions do not fully belong to you until after the end of the vesting period. For example, if your employer has a three-year vesting period, you must have been working for the employer for at least three years to claim 100% of the employer’s contributions.
If you take a hardship withdrawal before you have completed the vested period, you will only access the vested portion of your contributions. For example, if you want to withdraw $20,000, and only $18,000 is vested, you may be forced to take a lower distribution i.e. $18,000 to meet your needs than what you need. Otherwise, you may be forced to wait longer for the employer’s contributions to be vested, depending on the company’s vesting schedule.
Consequences of a 401(k) Hardship Withdrawal
Tax withholding
A 401(k) account is funded with pre-tax money, and this means you pay taxes when you withdraw funds. If you make a hardship withdrawal, the employer will withhold 20% of the amount you withdraw for taxes. For example, if you withdraw $20,000, the employer will withhold $4,000. You will only receive $16,000 from the distribution. You may end up owing more or less than the withholding tax, depending on your total income for the year.
IRS penalty
In addition to paying taxes on the distribution, you may be required to pay a penalty tax on the distribution. If you are below 59 ½, the IRS may assess an additional 10% penalty when you file tax. Assuming you have taken out $20,000, you will be required to pay $2000 in penalties.
Forego tax-deferred growth
When you withdraw money from your 401(k) before retirement, the funds taken out will no longer grow tax-deferred. This means you will have taken a step back in your retirement planning since you will be using your retirement savings for purposes other than meeting your retirement expenses.
