Employee Benefit Plans: The 411

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

Hardship Distribution Documentation

IRS requirements are surprisingly vague regarding hardship distributions. In the absence of clear-cut rules, we sometimes see hardship distributions with very little or no supporting documentation. As a plan administrator you should not only comply with the IRS requirements, but also document your compliance with these requirements. Let’s look at a few of the requirements and discuss some common sense ideas for documentation.

Requirement – The participant must demonstrate an “immediate and heavy financial need.”

Some plans require the participant to provide documentation supporting their financial need (i.e. medical bills, past due mortgage notices). Other plans may only require a signed affidavit. At the very least, we would recommend having documentation showing the steps that were taken to determine that a financial need existed. This could be as simple as a checklist that is followed for all hardship distributions. The most important consideration is that your process determining that a financial need exists must be applied the same way for all participants. If one participant is required to provide documentation and another only has to sign an affidavit, it could be considered discriminatory.

Requirement – The participant must have exhausted any other liquid sources of income.

It is not typical for plan administrators to request documentation regarding other liquid sources of income available (i.e. bank statements). Typically the plan administrator will just rely on an affidavit signed by the participant. However, as the plan administrator, you do have information regarding the participant’s eligibility for a 401(k) loan. Consider whether a participant that is still eligible for a 401(k) loan has “exhausted other liquid sources of income.” You might, at least, add to your checklist to inquire whether the participant has considered a 401(k) loan as an alternative to a hardship distribution.

Requirement – The hardship distribution cannot be approved for more than the qualified financial need.

The distribution can be grossed up for tax withholdings, but any additional distribution would not be allowed by the IRS requirements. In order to demonstrate that you took this requirement into consideration, you should at least include in your documentation the amount of the financial need that the participant has demonstrated.

Hopefully this article has given you some ideas on forming documentation policies for hardship distributions. Be sure to seek advice from your CPA and attorney if you have any questions specific to your plan.

For more information on IRS regulations regarding hardship distributions, visit http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Hardship-Distributions.

By Rex Platt, CPA