Loan Option

• Although your employer is under no legal obligation to include a loan option in your 401(k) plan, if there is one, IRS regulations state you must use it as a first option. Your employer or plan administrator sets the terms for these loans, including length of repayment, minimum and maximum amounts and optional loan fees. In most cases, according to Money-zine.com, the repayment term is 60 months, the minimum loan amount is $1,000, and the maximum loan amount is the smallest of 50 percent of the balance of your account or $50,000.
  
  

Hardship Distribution

• Just as with a 401(k) loan, your employer is under no legal obligation to include a hardship withdrawal option in your plan. However, if there is one, and you exhaust all other ways to pay your medical bills, you may qualify for a hardship distribution. In this case, the amount you withdraw cannot exceed the amount of the medical bill plus the tax and/or penalty you incur because of withdrawing funds from your 401(k) retirement plan.
  
  

Proving Financial Hardship

• The IRS does not identify qualifying medical expenses or list a minimum amount for the expense. Instead, IRS states the expenses you incur on behalf of yourself, your spouse, dependent or 401(k) beneficiary must be both immediate and heavy and you must have no other way to pay these expenses. Your employer or plan administrator, however, ultimately decides on the level of proof required to meet this definition.
  
  

Consequences

• You will face consequences no matter which method you use to withdraw funds from your 401(k) to pay outstanding medical bills. In both cases, your employer has the option to stop you from making any further contributions to your 401(k) plan until you repay the loan. This can result in a significant reduction in retirement savings, especially if your employer matches a percentage of your contribution. In addition, the interest you pay on the loan is not deductible on your annual income tax return. If you take a hardship distribution, you will incur penalties for early withdrawal, as well as be responsible for paying income tax on the amount you withdraw. In total, this can result in a 35 to 45 percent reduction in the amount you ultimately receive.