Failure to Comply with Hardship Distribution Requirements

Failure to Comply with Hardship Distribution Requirements

Valuable Information on 401ks, Pensions, ESOPs, Form 5500 Preparation + More

Plan Sponsors often fall short in one simple area of plan administration: record keeping. It is important that Plan Sponsors keep proper documentation for each area of the Plan.  One important area for this documentation is administering hardship distributions to participants. As described in our blog, “Hardship Distribution Requirements”, if your plan allows for hardship distributions, you as the Plan Sponsor should have proper procedures in place to determine the employee has immediate and necessary need for the funds.

If you are not sure proper documentation has been retained for hardship distributions for your Plan, review all distributions made during the year and determine which were distributed as hardships. For each of the hardship distributions, review the documentation to determine if each meets the hardship distribution requirements set forth by the Internal Revenue Service. Also review for any signs that the hardship distribution is being abused by employees. If there are quite a few hardship distributions, this may be a sign that the hardship distributions are not being properly administered.

If you do find a mistake with the administering of hardship distributions within your plan, there are some corrective measures that can be taken. For example, if you have determined that proper documentation was not retained for hardship withdrawals, you may correct this under the Voluntary Correction Program (VCP). As the Plan Sponsor, you must request that the participants who did not provide proper documentation and did not meet the hardship requirements repay the amounts plus earnings to the plan. This could be a tedious act as most participants would have previously spent their distribution. Correction may include paybacks, employer corrective contributions and even some form of plan amendment. Each situation will be different and therefore, you should file an application with the VCP and work with an agent there to determine the appropriate correction necessary.   Additional information about deficiencies found and remedies recommended by the IRS can be found at this IRS website.

In addition to correcting the specific participants, the Plan Sponsor must improve the plan’s administrative procedures in order to keep it out of further trouble with regards to hardship distributions. Whenever a hardship distribution requests is submitted, it is important for the Plan Sponsor to require additional documents to be received and placed on file with the request to back up the hardship. This will show that adequate steps have been followed by the Plan Sponsor to determine that the employee does in fact have a need that is immediate and necessary for the funds.

For further information on what is required for a hardship distribution to be taken, visit the Internal Revenue Service’s website.

Shelby Williams