The IRS provides employee plan (EP) examiners with the following guidance to help 401(k) sponsors’ understand their obligations with regard to safe-harbor hardship distributions, which are a frequent source of IRS examination.
Under U.S. tax laws, companies that sponsor 401(k) plans may allow plan participants to tap into their retirement savings prior to reaching retirement age when those employees demonstrate they have an “immediate and heavy financial need.” Satisfying this financial hardship through a 401(k) withdrawal requires an assessment of the plan’s terms and the individual facts and circumstances surrounding the participant’s request. In general, the IRS considers the following expenses to meet its definition of immediate and heavy financial need:
Historically, substantiating that a distribution was necessary for a covered hardship further required appropriate documentation and verification by both the employee and the employer. Employees were required to provide their employers with documented evidence to justify financial need. Retirement plan sponsors and/or third-party administrators had an equally important obligation to review employees’ source documents, to determine whether or not they substantiate the employees’ request for a hardship distribution and to notify the employees of their decisions before making any distributions.
Under an IRS memorandum, plan sponsors are relieved of their responsibilities to collect and maintain source documents that support a plan participant’s hardship claim. Under certain conditions, a plan may instead obtain from the employee a self-certified summary confirming the veracity of the employee’s immediate need for the safe harbor hardship distribution while providing the employee with a notice to maintain source documents supporting the financial hardship.
Self-certified summaries for hardship claims require plan participants to provide sponsors with basic information to substantiate claims, such as their names, the total costs of the events causing the hardship and the amount requested. However, additional information may be required, depending on the reason for the hardship. For example, in order to receive a hardship distribution to cover funeral and burial expenses, a plan participant must include in the summary the name of the deceased, his or her relationship to the deceased, the date of death, and the name and address of the funeral home or cemetery providing services. To summarize a request for expenses to repair a principal residence, the plan participant must include the address of the residence, the date and cause of the casualty loss, and the repairs required and dates they are made. In turn, plan sponsors and/or third-party administrators must maintain those summaries and verify participants’ claims. In addition, the plan or its administrator may rely on the summary method only when it notifies the employee of the following:
While self-certified summaries may alleviate a plan’s record-keeping burden, special consideration should be given to how practical it is to place this responsibility on the shoulders of plan participants who may not have the best processes in place to maintain accurate records. Those plan sponsors that wish to move forward and adopt the summary method for hardship claims should meet with their advisors to ensure they have the proper documentation and processes in place to do so.
The professionals with Provenance Wealth Advisors work with businesses of all sizes, through start-ups, mergers and acquisitions, to design benefits plans and implement best practices to meet regulatory compliance and serve the needs of plan sponsors and participants.
About the Author: Sean Deviney is a CFP®* professional and retirement plan advisor with Provenance Wealth Advisors (PWA), an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors and Accountants, and a registered representative with Raymond James Financial Services. For more information, call (954) 712-8888 or email firstname.lastname@example.org.
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Sean Deviney is a registered representative of and offers securities through Raymond James Financial Services, Inc., Member FINRA/SIPC. Raymond James is not affiliated with and does not endorse the opinions or services of Berkowitz Pollack Brant Advisors and Accountants.
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* Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.