Can I use a 401k hardship withdrawal to pay off car loan

Can I use a 401k hardship withdrawal to pay off car loan
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#1

I want to take a hardship withdrawal out of 401k to pay off car loan. I already have maximum amount of loans I can get already so I can only do a hardship. I’ve already talked to them and I know my employer lets me take the hardship and they don’t require any documentation for what the hardship is for . I know there are all the penalties and taxes which is fine I’m not worried about that . Is there anything else that I can get in trouble for when taking out a hardship withdrawal when its not one of the required reasons to take a hardship??


#2

Hi, Michael, and welcome to the forum. It would help to know why it’s so important to pay off this car loan. Normally we would never advise using retirement money to do something like that. The penalties and taxes you would pay on the withdrawal far exceed even the highest interest rate you’re likely to pay on the car, and that doesn’t factor in the future tax-deferred earnings you would lose. (As a rule of thumb, you can expect to lose one quarter to one half of any withdrawal to taxes and penalties, but you’ll lose 10 times or more the amount of the withdrawal when you factor in lost future returns. The math is really brutal.)

It sounds like this car loan is really giving you trouble though. If you give us more details, we may be able to point you to some resources that could help.


#3

I believe the worst the IRS can do to you is what it is already going to do: taking 10% of your hardship withdrawal as a penalty, in addition to the income taxes you’ll owe. That’s the way it handles any early withdrawal from a 401k.

On the other hand, employers aren’t supposed to hand you money from the plan except under specific circumstances, such as when you leave the company or turn 59 1/2. Many allow loans, as you know.

And while employers can distribute proceeds under hardship withdrawals, they are required to seek proof that your need fits one of the allowed circumstances. It’s unusual that your employer wouldn’t ask for this.

Hardship withdrawals are permissible for medical care/costs, buying a home, paying for college, preventing foreclosure or eviction, funeral expenses, or home repairs.

(This is a pretty bold move, and we typically would tell you to consider counseling or even bankruptcy before looting your retirement. If you’ve maxed out loans and are considering this there is a bigger problem than just the car.)


#4

What are the consequences to the employer if they distribute funds from your retirement account without proper verification of hardship? Are they at risk of any penalties or fines?


#5

The IRS would likely require that they try fix the mistake, up to and including trying to claw back the money from the employee. I’m sure they can levy all kinds of fines and penalties as well, because IRS.