Rules vary for hardship withdrawals from IRAs and 401(k)s

Q I took some money out of my 401(k) for an emergency this year. Can I repay my 401(k) in 2010 without paying tax and penalty?

KAREN

A All retirement savings plan share a common goal: to encourage people to save for their old age. Yet 401(k)s, 403(b)s, 457s, IRAs, Roth IRAs, SIMPLE IRAs, SEP IRAs and other retirement savings plans often have different rules, restrictions and benefits. For example, with an IRA you can take money out tax-free and penalty-free for 60 days. However, you must return the full amount back to the account within the 60-day time period. If you miss the deadline you'll owe ordinary income taxes and pay a 10 percent penalty (assuming you're under 59 1/2). You can return the money to your IRA or open a new one. You can do this only once in any 12-month period.

But you can't do a similar maneuver with a 401(k). Simply put, you can't put back the money you took out of your plan.

That's assuming you made a hardship withdrawal or similar distribution from the plan. The hardship clauses are highly restrictive. You have to document the need for the money to the plan administrator. The rules are designed to make this your last-resort money. And employers don't have to allow it.

Among the situations that qualify for a hardship withdrawal are steep medical expenses, to prevent eviction from your home, college tuition and funeral expenses. In almost all cases you'll still be socked with an income tax bill from Uncle Sam and a 10 percent penalty on the withdrawal. However, there are a handful of circumstances where you can get a penalty-free -- but still taxable -- withdrawal.

The reasons include total disability and a court order to pay money to your divorced spouse, child or dependent. And you can't return hardship distributions into the plan once the emergency is over. The IRS offers an overview of the rules online; just Google the phrase Retirement Plans FAQ regarding Hardship Distributions.

If this is how you got the money out of the plan, then the loan is paid back through payroll deduction. The interest rate is usually the prime rate plus one percentage point. You won't owe any income tax or penalty on the loan amount. That said, a major risk with this loan is if you lose your job or change employers, you have 60 days to pay off the loan. The amount outstanding after 60 days is treated as an early withdrawal. You'll be hit with income taxes and penalty (again, assuming you're under 59 1/2). Plus, you're losing the benefit of your investment money compounding over time.

By the way, you can't borrow against an IRA. Go figure.

I wish there was one set of rules for all retirement savings plans. But until that day -- and I wouldn't hold my breath -- savers have to navigate the complicated requirements.