Company retirement plans, such as solo 401k plans, 403(b)s, and government 457(b)s, can (but aren’t required to) allow employees to take hardship distributions. A hardship distribution is one that is made for an immediate and heavy financial need of the employee, his spouse, or dependents. The solo 401k plan document has to provide objective and nondiscriminatory standards to determine what a hardship is. As the name implies, it must be for a financial hardship or emergency, not to go on vacation or buy a sports car. A solo 401k plan might allow hardship distributions for medical and funeral expenses or to prevent eviction, but not to buy a motorcycle. IRS regulation section 1.401(k)-1(d)(3) contains detailed rules on what is and is not considered a hardship. Usually the amount that can be withdrawn is limited under the plan’s terms to the employee contributions or any amounts that have been transferred it form other retirement plans and IRAs.
Hardship distributions are taxable (unless they consist of designated Roth Solo 401k contributions or other voluntary after-tax solo 401k contributions) and are subject to the 10% early distribution penalty if the participant is under 59½ at the time of the distribution. Also, hardship distributions are not rollover eligible to an IRA or other company plan.
How does a participant show that he or she is experiencing a hardship?
Most solo 401k plans use the deemed necessary” rules described in Q&A-2 of the IRS page listed HERE. Generally, the solo 401k owner will need to produce the hardship backup paperwork to the IRS at time of audit, not at time of distribution or on their Form 1040.