Retirement plan sponsors have long struggled with obtaining documentation from participants to support hardship distribution claims. There has been uncertainty over the type of documentation required and as to who was responsible for verifying the claim. In February 2017, the Treasury Department issued a “Memorandum for Employee Plans Examinations” outlining substantiation guidelines for safe harbor hardship distributions from 401(k) and 403(b) plans. It provides a simple mechanism of self-certification by an employee to demonstrate hardship events that should be less burdensome for plan sponsors. While the memorandum is directed at IRS employees conducting examinations of plans, it provides valuable guidance to plan sponsors regarding the preferred
IRS method for documenting hardship claims.
Generally, 401(k) and 403(b) plans may permit distributions on account of financial hardship if the distribution is made on account of an “immediate and heavy financial need” and the distribution does not exceed the amount needed to satisfy the financial need. A distribution is deemed to be for an immediate and heavy financial need if it is made for any one or combination of the reasons set forth in the Treasury regulations, such as medical expenses, the purchase of or substantial repairs to a primary residence, college tuition, to prevent eviction, or funeral expenses. Prior to this guidance, a participant had to present documented proof of existing hardship, which required detailed disclosure of the participant’s financial situation.
The new guidelines provide a streamlined documentation process. Rather than retaining source documents (such as bills, statements, etc.), an employer may retain a summary of information contained in the source documents. For all types of hardship distributions, the summary must contain the:
- participant’s name;
- total cost of event causing the hardship (for example, total cost of medical care, total cost of funeral/burial expenses, payment needed to avoid foreclosure or eviction);
- amount of distribution requested; and
- certification by the participant that the information provided is true and accurate.
In addition, the summary must include basic information specific to the type of hardship involved. For example, a summary for a hardship distribution for funeral and burial expenses must include the name of the deceased, the relationship to the participant, date of death, and the name and address of the service (cemetery, funeral home, etc.).
If summary information provided by an employee to the plan appears to be incomplete or inconsistent, the examining IRS agent may request backup documents to substantiate the hardship from the employer or third party administrator.
If an employee receives more than two hardship withdrawals in one plan year, the IRS noted that an agent may, with managerial approval and in the absence of an adequate explanation, request additional physical backup documentation to verify the hardships.
To rely on such a summary, the employee obtaining a hardship distribution must be provided a notice containing the following information:
- The hardship distribution is taxable and additional penalties could apply.
- The distribution cannot exceed the immediate and heavy financial need.
- Hardship distributions cannot be made from earnings on elective contributions or from qualified non-elective contribution (QNEC) or qualified matching contribution (QMAC), if applicable.
- The recipient agrees to preserve source documents and make them available upon request to the employer or plan administrator at any time.
Third party administrators should provide a report or other data to the employer, at least annually, that describes hardship withdrawals made during the plan year.
Employers sponsoring 401(k) or 403(b) plans that offer hardship distributions should review their hardship distribution procedures and revise them to conform to the guidelines set out in the IRS memorandum.
If you have any questions about the new guidelines or require any assistance in determining whether your plan is meeting its substantiation and documentation requirements, please contact Connie Lee at firstname.lastname@example.org or 844.4WINDES (844.494.6337).