Are Hardship Withdrawals Taxed? Income Tax, Penalties, and Exceptions

Yes, hardship withdrawals are taxed. The IRS treats a hardship distribution from a 401(k) or 403(b) as ordinary income for the year you receive it, and if you are under age 59½, a 10% early withdrawal penalty applies on top of the income tax in most cases.¹ Because the money went in pre-tax, every dollar you pull out — contributions and earnings — counts as taxable income. And unlike other plan distributions, a hardship withdrawal cannot be rolled over or repaid, so the tax hit is permanent.

How the Income Tax Works

The full amount of the withdrawal is added to your gross income and taxed at your ordinary income tax rate. A large distribution can push part of your income into a higher marginal bracket, raising the rate you pay on income above that threshold.²

There is one meaningful exception. If your plan offers a designated Roth 401(k) and part of your distribution comes from Roth contributions, that portion is not included in gross income, because you already paid tax on those dollars when you earned them.¹

Withholding at the Time of Distribution

Hardship distributions cannot be rolled into another retirement plan or IRA, so they are classified as nonperiodic distributions rather than eligible rollover distributions. That classification changes the withholding rule. The mandatory 20% withholding that applies to eligible rollover distributions does not apply here. Your plan administrator withholds 10% of the taxable amount by default, and you can elect out of withholding entirely if you prefer.³

The 10% withheld is only a prepayment against what you owe, not the final bill. If your combined federal income tax, state tax, and the 10% early withdrawal penalty exceed what was withheld, you will owe the difference when you file. Many people are surprised by this at tax time.

The 10% Early Withdrawal Penalty

If you are younger than 59½ when the distribution is made, the IRS adds a 10% additional tax on the taxable portion of the withdrawal. This penalty is separate from the regular income tax you owe.⁴ It applies regardless of your reason for taking the money out or how much you earn.

The combined bite adds up fast. Someone in the 22% federal bracket loses at least 32% of the withdrawal to federal tax alone once the penalty is added. In the 24% bracket, it is at least 34%. State tax comes on top of that.

Exceptions That Apply to 401(k) and 403(b) Plans

Several situations remove the 10% penalty, though regular income tax still applies to the withdrawal. The exceptions available to qualified plan participants include:⁵

Unreimbursed medical expenses above 7.5% of adjusted gross income.
Separation from service during or after the calendar year you turn 55 (age 50 for certain public safety employees).
A series of substantially equal periodic payments based on your life expectancy.
Total and permanent disability as defined in the tax code.
Distributions taken to satisfy an IRS levy on the plan.
Distributions to an alternate payee under a qualified domestic relations order.

One important boundary: the penalty exceptions for higher education expenses and first-time home purchases apply only to IRAs. You can take a hardship withdrawal from a 401(k) for tuition or to buy a home — both are qualifying hardship reasons — but the 10% penalty still applies if you are under 59½.⁵

Newer SECURE 2.0 Exceptions

The SECURE 2.0 Act added categories of penalty-free withdrawals from qualified plans. These are optional for plan sponsors, so confirm with your administrator that your plan has adopted them.

Emergency personal expense withdrawals allow one penalty-free distribution per calendar year of up to $1,000 for unforeseeable or immediate personal or family emergencies. Repay within three years and it is treated as a rollover, not taxable income. If you do not repay, you must wait three full calendar years before taking another under this provision.⁵

Survivors of domestic abuse within the past 12 months may withdraw the lesser of $10,000 or 50% of the vested account balance without penalty. You self-certify, and repayments made within three years are treated as rollovers. Withholding on these distributions is 10% rather than the standard rate.⁵

If a physician certifies a terminal illness, distributions are exempt from the 10% penalty, and you have three years to repay for rollover treatment. Regular income tax still applies.⁵

For federally declared disasters affecting your principal residence or workplace, you can withdraw up to $22,000 per disaster without the penalty, with three years to repay for rollover treatment. This provision covers disasters declared after January 26, 2021.

State Income Tax

Most states with an income tax include hardship withdrawals in state gross income, on the same basis as the federal rules. Rates vary widely: residents of states with no income tax skip this layer entirely, while high-tax states can add 10% or more on top of the federal bill.

A few states also impose their own early withdrawal penalty. California, for example, adds a 2.5% state penalty on top of the federal 10%. Most states do not have a separate early withdrawal penalty. State-level exceptions do not always match the federal list, so check your state rules before you file.

Reporting the Withdrawal on Your Tax Return

Your plan administrator sends you a Form 1099-R for the year of the distribution. Box 1 shows the gross amount, and Box 7 carries a distribution code. For an early withdrawal with no known exception, the administrator typically enters Code 1.⁶ You report the taxable amount on your Form 1040.

If you qualify for a penalty exception, file Form 5329 with your return and enter the exception code that matches your situation.⁷ Skip this step when your 1099-R shows Code 1 and the IRS will assess the 10% penalty automatically, since Code 1 signals no exception was identified when the distribution was made. Fixing it later means responding to an IRS notice.

Hardship Withdrawal vs. 401(k) Loan

If your plan offers loans, that route often costs less in tax. A loan is not taxed as long as you follow the repayment schedule, does not trigger the 10% penalty, and repayments — with interest — go back into your own account.⁸ A hardship withdrawal is taxed immediately, may carry the penalty, and cannot be repaid.⁹

The loan has its own risk. If you leave your job with an outstanding balance and cannot repay, the unpaid amount is treated as a taxable distribution and can trigger the 10% penalty.¹⁰ Some plans also require you to exhaust available loans before approving a hardship distribution.

Under the safe harbor rules, most plans limit a hardship withdrawal to the amount needed to satisfy the financial need, including the taxes and penalties the withdrawal itself will generate.² Build that gross-up into your request. Ask for only what will cover the expense and every dollar owed once federal, state, and penalty taxes come due.

1
Internal Revenue Service. Retirement Topics – Hardship Distributions
2
Internal Revenue Service. Retirement Plans FAQs Regarding Hardship Distributions
3
Office of the Law Revision Counsel. 26 U.S. Code 3405 – Special Rules for Pensions, Annuities, and Certain Other Deferred Income
4
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
5
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
6
Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498
7
Internal Revenue Service. Instructions for Form 5329
8
Internal Revenue Service. Hardships, Early Withdrawals and Loans
9
Internal Revenue Service. Retirement Topics – Hardship Distributions
10
Internal Revenue Service. Retirement Plans FAQs Regarding Loans