Medical bills can add up very quickly, especially if you are between health insurance policies. While hospitals can use aggressive collection methods, the laws limit what accounts they can try to take money from for unpaid bills. Funds that you have in a 401(k) retirement account at work are protected from just about every type of collection.
Legal Protection for 401(k)s
Work retirement plans such as a 401(k) are protected from just about every type of claim. This is a result of the 1974 Employee Retirement Income Security Act (ERISA), explains the U.S. Department of Labor. The law set boundaries to protect these types of accounts from being seized by creditors and protect the financial stability of individuals for retirement.
The primary exception to this rule is that the Internal Revenue Service can pull money out of your 401(k) to pay a tax levy. Hospitals can't take them, though. Your other retirement accounts don't receive the same protections, though. For example, your individual retirement account (IRA) enjoys at least $1 million of protection in a bankruptcy.
Hospital Collection Agencies
While a hospital can't go after your 401(k) plan, it can come after you if you owe money. Many hospitals will work with you if you talk to their representatives when you get the bill and try to make some payments. Once the hospital gives up, though, it may send the bill to a collection agency. Collection agencies can use a range of methods to collect, including suing you.
401(k) Loan Stipulations
If you want to pay your medical bills but can't afford to, a 401(k) loan might be an option for you. If your employer allows it, you can generally take out half of your plan's balance, up to $50,000, as a loan. You will have to pay back the loan within five years, and you will have to pay interest. However, you'll actually be paying the interest to yourself, as that's your money in the 401(k).
401(k) Hardship Withdrawals
If you don't think you can afford to pay back the loan or if your employer won't let you take a loan from the 401(k), you might be able to withdraw the money from your 401(k) to pay off your hospital bill. As with loans, your employer will have to let you do it.
When you take out a hardship withdrawal, everything you take out will be taxable, cautions FINRA. In addition, you will have to pay a 10 percent penalty, unless the medical expenses exceed 10 percent of your adjusted gross income. In that case, the amount you withdraw to pay bills that exceed that threshold would be penalty-free.
However, unlike a loan against your 401(k), a withdrawal as a result of a hardship is not allowed to be paid back. It is taken as income, where you'll pay income taxes and the possible 10 percent penalty, and left as a deduction from your 401(k) account.
There are a some exceptions for those who are allowed to access the hardship withdrawals. Most importantly, the withdrawal needs to be approved by the employer and allowed under the specific 401(k) plan.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.