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Compliance Matters- Hardship Requests Require Extra Diligence

Posted by Emily Taibl on Jan 19, 2017 3:36:05 PM

Retirement Plan Hardship Requests - Seattle CPA Managing participant hardship distributions has always required vigilance. The rules are complex, and it’s easy to step off the straight and narrow.

Adding to the challenge is the ease with which employees can initiate hardship requests via a third party administrator (TPA). The requests typically come in electronically via a secure web portal. The TPA then uses the most current information it has to process the request.

It is essential that plan administrators understand their role and responsibility in the approval process, which should be defined in the TPA service agreement. Further, plan administrators must ensure that the TPA has been provided current and accurate plan documents as well as accurate participant census data. Plan administrators should gather documentation of the hardship and confirm that alternatives were explored. Not doing so jeopardizes the qualified status of your plan.

What Do Your Documents Say?

Any discussion of hardship withdrawals is moot if your plan does not allow them. Although not required, a retirement plan may allow hardship distributions from a participant’s elective deferral account, but plan documents must specifically state so.

Even then, plan sponsors may fail to follow the terms outlined in their plan. According to the IRS, common oversights include:

  • Making hardship distributions when they aren’t permitted by the plan document,
  • Allowing distributions for reasons other than those stated in the plan document, and
  • Failing to suspend participant salary deferrals following a hardship distribution if required by plan terms.

If your plan does allow for such distributions, it will also need to adhere to IRS regulations. Here, the IRS has three primary requirements for hardship distributions:

  1. Participants must demonstrate immediate and heavy financial need,
  2. Participants must exhaust other liquid sources of income prior to making a hardship request, and
  3. Distributions cannot be in excess of the amount necessary to satisfy the hardship need.

Burden of Proof

The burden of proof for each requirement rests on the employer, not the TPA. In addition, plan documents should detail the following:

The funds available — The plan must clearly state any limits on the type of funds available for distribution. For example, distributions may be limited to the employee’s total elective contributions and Roth contributions. Plan documents might also state that funds are available from vested employer matching and profit sharing contributions. 

The specific criteria — The IRS notes that if a 401(k) plan allows hardship distributions, it must provide the specific criteria used to make the determination of hardship. For example, a plan may state that distributions can only be made for medical or funeral expenses, but not for the purchase of a principal residence or for payment of tuition and education expenses.

In determining the existence of a need and of the amount necessary to meet the need, the plan must specify and apply nondiscriminatory and objective standards.

The hardship request procedure — A clearly defined hardship request policy, complete with procedural steps for qualification and approval, ensures that plan administrators, employees and TPAs understand what documentation is required, who is responsible in securing it and where it is stored. The TPA helps with process facilitation, but it is still prudent to have all required documents submitted to and reviewed by plan administrators. 

Three Questions to Ask

It’s important to understand what the law and your plan document allow. In particular, you should know the answers to these three questions:

  1. Did the requesting employee explore alternative funding first, and has the search been documented?
  2. Did the employee provide documentation of the hardship?
  3. If a hardship withdrawal is approved, where is this documentation stored, and is it easily accessible to plan administrators?

Without full knowledge of the rules, plan administrators tend to err on the side of being overly lenient with hardship requests. Take this opportunity to review your plan’s provisions. And remember that inconsistent or overly liberal distributions may result in significant issues for the plan.

If you have questions about your plan documents or processes, contact Wende Wadsworth at Sweeney Conrad, P.S. at 425.629.1990.

Topics: Retirement Reporter, Tax

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