Avoiding the 10% Early Distribution Penalty for Certain Hardship Withdrawals
Most 401(k) plans (as well as 403(b) and 457(b) plans) offer hardship withdrawals while you are still employed. If the withdrawal comes from a pre-tax account, it will be taxable. And, if you’re under age 59½, it will also be subject to the 10% early distribution penalty – unless one of the exceptions to that penalty applies. For example, hardship withdrawals are allowed for medical expenses. But because medical expense withdrawals are often exempt from the 10% penalty, you usually won’t be hit with a penalty if you take a hardship withdrawal before age 59½ to pay for those expenses.
The SECURE 2.0 Act expanded the list of exceptions to the 10% penalty. The new exceptions include withdrawals for:
- Victims of federally-declared disasters (effective January 26, 2021)
- Terminally-ill persons (effective in 2023)
- Victims of domestic abuse (effective in 2024)
- Emergency expenses (effective in 2024)
For plans, these exceptions are also new distribution events allowing you access to your accounts before age 59½. However, SECURE 2.0 is clear that allowing access in each of these situations is optional. There is no requirement for a plan to allow these new distribution events, and many plans do not because of administrative concerns. But plans that don’t allow these new SECURE 2.0 distributions often still allow you to take hardship withdrawals for expenses that would have been covered if the plan did offer the new distribution. In that case, the hardship withdrawal will likely be taxable. But will it also subject you to the 10% penalty if you’re under 59½?
Fortunately, the answer is “no.” The IRS has said that if you take a hardship withdrawal before age 59½ and you are a victim of a federally-declared disaster, are terminally ill, are a victim of domestic abuse, or have an emergency expense, you are exempt from penalty as long as you would have qualified for the SECURE 2.0 distribution event if the plan offered it.
Hardship Withdrawal Example
Hannah participates in a 401(k) plan that allows hardship withdrawals but doesn’t permit the new penalty-free distribution event for emergency expenses. In 2025, at age 50, Hannah incurs an emergency expense and she qualifies for a hardship withdrawal for those expenses from a pre-tax account. The emergency expense exception allows only one penalty-free withdrawal per calendar year, and each distribution is limited to $1,000. So, if Hannah’s hardship withdrawal is no more than $1,000, and it is the first one she takes in 2025 for emergency expenses, she would qualify for the emergency expense distribution if the plan offered it. This means that although her hardship withdrawal will be taxable, Hannah will not have to pay the 10% penalty on it.
How does Hannah claim the emergency expense exception? She files Form 5329 and attaches it to her 2025 Form 1040. On line 2 of Part I of the 5329, she uses Code 23 for an emergency expense. Code 20 is used for terminal illness, and Code 22 is used for domestic abuse. If you are claiming the exception for a federally-declared disaster, you must use Form 8915-F instead of Form 5329.
By Ian Berger, JD
IRA Analyst
Ed Slott and Company, LLC
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Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.