Making a 401k Withdrawal for Medical Expenses
Understand the financial considerations and procedural requirements for using retirement savings to cover significant, unreimbursed healthcare costs.
Accessing your 401k funds for a medical event is possible under Internal Revenue Service (IRS) rules for hardship withdrawals. These provisions are designed for those facing serious financial burdens. Taking money from a retirement account has lasting consequences, so understanding the regulations is an important first step.
Determining Eligibility for a Hardship Withdrawal
A hardship withdrawal is a distribution from a 401k account due to a financial burden. To qualify for medical reasons, the IRS requires you to meet two tests. The first is the “immediate and heavy financial need” test, which is met by having unreimbursed medical expenses for yourself, your spouse, dependents, or your plan beneficiary.
The second requirement is the “necessary to satisfy the need” test. This means the amount you withdraw cannot exceed the actual cost of the medical care. You must also certify that you lack other available cash or liquid assets to cover the expense.
Not all 401k plans permit hardship withdrawals. You must confirm that your specific plan allows for them by checking the Summary Plan Description (SPD). If your plan allows these distributions, the SPD will specify the conditions.
Some plans may also permit an “emergency savings withdrawal” of up to $1,000 once per year. This type of withdrawal is not subject to the 10% early withdrawal penalty but is subject to income tax. The amount can be repaid within three years, and no further emergency withdrawals are permitted until it is repaid.
Understanding the Tax and Penalty Implications
A hardship withdrawal is included in your gross income for the year it is taken and is subject to ordinary income tax. For example, a $20,000 withdrawal for someone in the 22% federal tax bracket adds $4,400 to their tax bill, plus any state income taxes. Your plan administrator will report the withdrawal to you and the IRS on Form 1099-R.
Individuals under age 59 ½ are also subject to a 10% early withdrawal penalty on top of income taxes. This penalty is designed to discourage the premature use of retirement funds. For instance, a $20,000 withdrawal would incur a $2,000 penalty.
An exception to the 10% penalty exists for unreimbursed medical expenses that exceed 7.5% of your Adjusted Gross Income (AGI). Your AGI is your gross income minus specific deductions and is found on your Form 1040. You can avoid the penalty only on the portion of your withdrawal that covers expenses above this 7.5% threshold.
For example, if your AGI is $90,000, your 7.5% threshold is $6,750. If you have $20,000 in medical bills and withdraw that amount, only the portion exceeding the threshold ($13,250) is exempt from the 10% penalty. The remaining $6,750 of the withdrawal would still be subject to a $675 penalty.
Required Information and Documentation
To initiate a withdrawal, you must provide your 401k plan administrator with proof of the medical need. This includes detailed invoices from healthcare providers and Explanation of Benefits (EOB) statements from your insurance company. EOBs show what insurance has paid and what costs remain your responsibility.
You must obtain a hardship withdrawal application from your 401k plan administrator. This form will require your personal and employment information.
The application requires you to state the reason for the withdrawal and the exact amount requested. You must use your financial documents to justify this amount. You may also need to certify that you have no other available funds to meet the obligation.
The Withdrawal Process
Submit the completed application and supporting documents to your 401k plan administrator. Submission methods vary by plan and may include secure online portals, mail, or fax.
The plan administrator will review your request to ensure it meets IRS regulations and your plan’s rules, which takes five to ten business days. The administrator verifies the hardship and the amount requested against your documentation.
Upon approval, you will receive a confirmation notice. The funds are then disbursed via the method you selected, such as direct deposit or a mailed check. It may take several additional days for the funds to become available in your account after disbursement.
Reporting the Withdrawal on Your Tax Return
After the year of the withdrawal, your plan administrator will send you Form 1099-R. This form reports the total withdrawal amount and includes a distribution code. For an early withdrawal, this is often Code 1, indicating an early distribution with no known exception to the penalty.
You must claim the medical expense exception on your personal income tax return to avoid the penalty on the qualifying portion of the funds. This is done by filing Form 5329 with your annual Form 1040 tax return.
On Form 5329, you will report the total early distribution and calculate the amount that is exempt from the penalty. You will enter your total unreimbursed medical expenses and calculate the 7.5% AGI limitation to determine the portion of your withdrawal not subject to the tax. This exempt amount is subtracted from your total distribution, so you only pay the penalty on the non-qualifying portion.