March 31, 2017

401(k) Safe Harbor Hardship Distribution Rules

Most 401(k) plans offer participants the opportunity to make safe harbor hardship distributions in dire circumstances. Unexpected expenses for medical, health or even funeral care may be covered by a hardship distribution assuming the proper criterion is met. While a useful benefit for participants, there is concern that in some cases regulations are not being properly followed. To ensure compliance, the IRS recently issued a memorandum for their examiners (effective for plans currently under examination or have an examination opened February 23, 2017 or later) that provides clarity in determining whether a plan has acted properly. The information is important for plan administrators because it provides insights into how the IRS interprets and applies these regulations when reviewing and examining plans. To help clients, prospects and others understand the implications, Wilson Lewis has provided an overview summary below.

Valid Hardship Distribution Reasons

According to the memorandum, a safe harbor hardship distribution is only permitted in situations where an employee has an “immediate and heavy financial need” and the distribution is necessary to satisfy that need. As a reminder, the IRS permits hardship withdrawals for (only) the following reasons:

• Medical Expenses – to pay for unreimbursed medical expenses (those that would be deductible) for the plan participant or their spouse, children, dependents or the primary beneficiary under the plan
• Primary Residence Purchase – for the purchase of the plan participant’s principal residence, excluding mortgage payments
• Prevent Eviction/Foreclosure – to make payments necessary to prevent eviction of the plan participant from their principal residence or prevent foreclosure on the mortgage of the principal residence
• Principal Residence Damage – to pay for repairs to the plan participant’s principal residence from a damaging event that is sudden, unexpected or unusual if the repairs fall under the IRS’s description of a casualty loss
• Post-secondary Education – to pay college tuition, related post-secondary education costs and room and board for the next 12 months for the plan participant or their spouse, dependent, child who is no longer a dependent or the primary beneficiary under the plan
• Funeral Expenses – to provide funeral or burial expenses for the plan participant’s deceased parents, spouse, children, dependents or primary beneficiary

It’s important to note that the hardship distribution amount may not exceed the amount needed to satisfy the hardship, but it can cover taxes and penalties.

Documentation Requirements

Since hardship withdrawals are subject to specific IRS restrictions, requiring and retaining proof of the hardship – and that it is indeed “heavy and immediate” – is crucial. The IRS memorandum notes that the employer or plan administrator should obtain source documents (e.g., employees’ late payment notices, estimates, contracts, bills, etc.), or a summary of information from source documents for examination.

If a summary is used, the memorandum identifies the particular information required, including specific notices that the employer must provide to the employee, requirements for general information and certification from the employee about the hardship and other specific details depending on the type of hardship event. Additional information may be required if an employee has received more than two hardship distributions in a plan year.

Contact Us

Carefully following the information outlined above will ensure the plan complies IRS and other regulations. If you have questions about safe harbor hardship distributions, or would like to discuss 401(k) or other plan concerns, Wilson Lewis can help. For additional information please call us at 770-476-1004, or click here to contact us. We look forward to speaking with you soon.