The IRS may be putting additional focus on the handling of hardship withdrawals for 401(k) plans. In a bulletin dated April 1, 2015, the IRS cautioned plan sponsors to ensure that certain documentation requirements are being met.
Many 401(k) plans, 403(b) plans and 457(b) plans permit hardship withdrawals to be taken. 457(b) plans refer to these withdrawals as “unforeseeable emergencies.” The IRS definition of a hardship is “an immediate and heavy financial need.” Such expenses typically include, but are not limited to:
1. Certain medical expenses
2. Payments to prevent eviction or foreclosure on a principal residence
3. Funeral expenses
4. Repair of damage to a principal residence
If a 401(k) plan provides for hardship distributions, it must provide the criteria used to make the determination of hardship. For example, a plan may provide that a distribution can be made only for medical or funeral expenses, but not for the purchase of a principal residence or for payment of tuition.
Record-Keeping Requirements for Hardship Withdrawals
Plan sponsors are ultimately the ones responsible for proper administration of their plans, including hardship withdrawal requests. Although many plan sponsors rely on their third party administrator to perform this function, the plans sponsor is still responsible. Certain recordkeeping requirements are necessary to be retained to support the hardship request. These include:
1. Documentation of the hardship request, review and approval;
2. Financial information and documentation that substantiates the employee’s immediate and heavy financial need;
3. Documentation to support that the hardship distribution was made in accordance with the applicable plan provisions and the Internal Revenue Code; and
4. Proof of the actual distribution made and related Forms 1099-R.
It should be noted that it is not sufficient to rely on the plan participant to retain such records. In addition, participants’ self-certification of hardship is not sufficient. Plan sponsors must also request and retain documentation to show the nature of the hardship. Overall, plan sponsors are responsible for ensuring that their plans are operating in accordance with applicable IRS and Department of Labor regulations and plan provisions regardless of their reliance on third party administrators and investment advisors.
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Source: Internal Revenue Service Employee Plans News, Issue No. 2015-4 (April 1, 2015).