Loans and Hardship Withdrawals

Many 401(k) and 403(b) plans permit participants to take loans on their balances and to withdraw money before retirement for reasons of hardship. Borrowing against the balance in a retirement account eliminates the tax advantage of holding the borrowed assets in a tax-favored account. Ordinarily, those assets would be earning tax-deferred returns; when the assets become principal on a loan, however, the participant supplies the "returns" in the form of interest payments--and thus receives no net benefit from his or her investment. Nevertheless, because retirement accounts cannot be used as collateral for commercial loans, cash-constrained participants whose plans permit the practice sometimes borrow directly from their retirement accounts.

Nearly half of the employees of medium-sized and large establishments who participated in 401(k) plans in 1997 were able to borrow against a portion of their balances for any reason; an additional 6 percent could borrow for purposes related to financial hardship. Early withdrawals were also available to 49 percent of the employees who participated in 401(k) plans in 2000; however, many of the plans limited early withdrawals to hardship cases. Only 19 percent of 401(k) participants could make early withdrawals in the absence of hardship.

Profit-sharing plans that are not considered 401(k)s may also permit early withdrawals or loans, but they are less common than in 401(k) plans. Fewer than one-third of participants in non-401(k) profit-sharing plans in medium-sized and large establishments could make early withdrawals or borrow against their account balances in 1997. Participants in 403(b) plans may secure hardship withdrawals only under conditions that, in many respects, are more stringent than those for avoiding the 10 percent penalty tax.(1) Loans from 403(b) plans are permitted, but employers generally limit them to cases of hardship. Section 457 plans occasionally permit hardship withdrawals, but they do not permit loans. Defined-benefit plans allow neither.

1.  Participants seeking to make withdrawals from 403(b) plans on the basis of hardship must demonstrate that they have no other financial means of making down payments on primary residences, or of paying tuition, medical expenses, or mortgages in the face of foreclosure. To avoid the penalty tax, withdrawals need only be smaller than the amount paid for the qualifying expense.

 
Sources:  Bureau of Labor Statistics, National Compensation Survey: Employee Benefits in Private Industry in the United States, 2000, p. 77.

Bureau of Labor Statistics, Employee Benefits in Medium and Large Private Establishments in 1997, pp. 132 and 137.