Substantiation of Hardship Distributions
Contributed by Mary Espinosa
The IRS recently issued two memorandums to its employee plan examiners indicating it is permissible for 401(k) and 403(b) plan sponsors and their service providers to rely on participants’ written summaries describing their financial hardships when processing hardship withdrawals from plans that apply safe harbor event rules.
A hardship distribution must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need. Types of hardship distributions that generally fall under the safe-harbor standards include unpaid medical expenses, purchase of a primary residence, payment of tuition, payments necessary to prevent eviction, funeral expenses, and certain expenses to repair damage to the primary residence. Substantiation that a requested hardship distribution is for one of the above reasons is required to determine that the distribution is based on an immediate and heavy financial need.
The IRS memorandums allow plans that apply the safe harbor standards’ rules to rely on a participant-provided summary of the financial hardship, provided that certain information is included in the summary. The plan sponsor or service provider must provide the participant with a notification containing certain information about the distribution. If certain requirements are met, the plan sponsor does not need to obtain source documents from the participant, on the condition that the participant agrees to retain and provide source documents upon request. If the distribution process is outsourced to a service provider, then the service provider will provide the plan sponsor, at least annually, a summary of the hardship withdrawals during the year or provide access to the summary information.
These memorandums are expected to assist plan administrators by providing insight and guidance as to what an IRS examiner may request upon audit and therefore what information should be obtained and maintained related to hardship withdrawals. As a best practice, we recommend plan sponsors review the plan’s controls and procedures surrounding hardship distributions. The sponsors should also verify whether hardship distributions are permissible under the plan document and discuss with service providers the roles and responsibilities of each party in the hardship distribution process, including providing the required notifications to participants.
This article originally appeared in BDO USA, LLP’s “EBP Commentator” blog (Spring 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com