I have read a lot on whether it is wise to withdraw 401(k) savings early to pay off debts. The answer is always "no." But I believe my situation may be different. Our two-income household has suddenly become one-income. Even if a new job is found, a pay cut is inevitable. Unemployment doesn't even cover food and gasoline.
Would it be considered a hardship withdrawal to pay off credit cards and medical bills with 401(k) money? Without additional income, we'll soon have to choose between paying the credit cards or the mortgage. Plus, we have a child going to college soon. We understand the 10 percent early withdrawal penalty plus taxes will hurt now. But we fear losing everything else. We have 20 years to rebuild our retirement funds.
Let's start with your first question, about hardship withdrawals. The Internal Revenue Service has specific rules for penalty-free hardship withdrawals. You would need to check with your 401(k) plan administrator for specific policies in place for hardship withdrawals with your plan. But keep in mind that, if you don't meet the IRS guidelines, you would still pay the penalty fee for early withdrawal as well as applicable taxes.
Now, let's move to the broader issues. The reason everything you read says "No, don't raid your 401(k) account to pay off debt" is that it's almost always the correct answer. It just doesn't make good financial sense when we are talking about paying unsecured debt like credit cards or medical bills. As you have discovered with this financial setback, you never know what is down the road in life. You need to leave your retirement funds intact because you may need them later much more than you do now.
In your case, there is another issue: job hunting. The answer to your specific situation lies in how long you think it will take to become a two-income household again. If you have good reason to believe the unemployment period is nearly over, then I'd say you could consider using some of the retirement funds to pay the card minimums. But don't pay them off. If extended unemployment is a real possibility, then I recommend you don't touch your retirement funds.
Here's my reasoning. A credit check often precedes a job offer. Using your retirement funds to pay the minimums will enable you to keep your payment history intact. A prospective employer who sees a bad credit record may infer you are unreliable, don't keep your promises or are irresponsible. No one is looking for those qualities in a new hire.
Additionally, it's not clear to me that you can cover your essential living expenses with just one salary even if you pay off your unsecured debts. What I recommend, if you have not done so already, is develop a bare-bones budget based on your current income.
Prioritize all your expenses. First on the list should be your mortgage and groceries. Transportation to get to work would be next, followed by utilities (drop your cable). These would be considered your essential bills that need to be paid each month.
Review your payroll deductions to see if you can reduce some. If you received a sizable refund last year, for instance, you can likely cut your tax withholding. If you can't cover all your essential expenses with your reduced income, then it makes no sense at all to use the 401(k). You'll still be underwater. But your 401(k) will remain intact and safe from collectors in most cases.
If you have not communicated with your card issuers and medical providers, do so now. Let them know your family has had a drastic reduction in income. As a result, you need to know what hardship programs they have for good customers who get economically blindsided. If you come up empty, ask to speak to a supervisor. They should have some help to offer you.
If your crisis drags out too long, you may want to speak with an attorney to understand your options for bankruptcy to get relief from your unsecured debt. You can find a listing of pro bono (free) bankruptcy attorneys on the website of the American Bankruptcy Institute.
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