Borrowing from 401k

Question

I have recently come into a difficult financial situation due to health issues and was considering taking out a hardship loan against by 401k to get it all paid off. I am wondering how this works and when I am asked what percentage I want to withhold, what do I put and what is this withholding for?

JMSSGV · Answer

If it's a withdrawal, you have to pay taxes on it no matter what your age is. But if you're under 59 1/2, there's also a penalty on top of the taxes. Medical expenses qualify for a partial exemption from the penalty, but only for the amount that exceeds 7.5% of your adjusted gross income (i.e., the amount that would be deductible if you itemized your deductions.)

There's no way to advise you on the amount you should have withheld without a lot more information. But the bottom line is that you will want to aim for a small amount due or a small refund when you file your return. All your withholding goes into one pool. You can always increase the withholding on your wages any time during the year if you think you might come up short.

Marmalade · Answer

It is allowed under my employer and I would request it as a hardship withdrawal and would therefore not be paying it back. I just don’t understand the withholding part and much percentage to enter. I am 42 so I realize I’d have to pay taxes on it. They said if you had 10% in medical expenses, that it was possible that you would not incur any penalties.

thank you!

JMSSGV · Answer

Are you referring to a LOAN or a hardship WITHDRAWAL? Two different things. If you take an actual loan, there's no immediate tax consequences, but if you fail to repay the loan it would be considered a withdrawal and you'd owe both income taxes and, if you're under 59 1/2, a penalty.

If it's a hardship distribution, you would owe income taxes in the year of the withdrawal, and possibly a penalty unless the reason makes you eligible for an exception. In this case, you'd need to indicate how much you want withheld for income taxes.

In both situations, your plan has to allow for these types of distributions. They are not required to.