In recent months, the IRS has advised plan sponsors to review recordkeeping requirements, due to a surge in employee benefit plan participants unrightfully taking (and “self-certifying”) hardship withdrawals from their benefit plans.

What’s a hardship distribution?

Sometimes we run into immediate and heavy financial needs. In situations like these, individuals can take a hardship withdrawal, which is a withdrawal from a participant's elective deferral account. You are limited to withdraw only the amount necessary to satisfy that financial need.

Common uses of a hardship withdrawal

The law permits a hardship withdrawal for specified purposes like:

• Burial or funeral expenses.
• Costs attached to the purchase of a principal residence
• Expenses for medical care that would be deductible under the Internal Revenue Code for the employee, or the employee’s spouse, child, dependent or primary beneficiary under the plan.
• Tuition-related educational fees, room and board for up to twelve months of post-secondary education for the employee or the employee’s spouse, child, etc.
• Expenses needed to prevent the employee’s eviction from his/her principal residence or foreclosure on the mortgage on that residence;
• Damage expenses for repairing the employee’s principal residence (that would qualify for the casualty deduction under Code Section 165)

What accounts can you take hardship distributions from?

A retirement plan may, but is not required to, provide for hardship distributions. A plan cannot make a distribution on account of a hardship unless the plan specifically provides for it. Many 401(k) and 403(b) plans that provide for elective deferrals provide also for hardship distributions.

Duty of plan sponsors

In January, the IRS reminded plan sponsors that tracking loans and hardship distributions is their responsibility, and said that electronic self-certification will not be as sufficient documentation of the nature of an employee’s hardship. Plan sponsors must obtain and retain records of any and all hardship distributions.

Documents needed, per IRS guidance:

1. Financial information and documentation that indicates the employee’s immediate and heavy financial need.
2. Documentation of the hardship request, review and approval;
3. Documentation to support that the hardship distribution was properly made according to applicable plan provisions and the IRC.
4. Proof of the actual distribution made and related forms 1099-R.

Self-certifying problem

Plan participants cannot solely keep their own records of hardship distributions—that is insufficient recordkeeping. Participants’ records may be inaccessible during an IRS audit of the plan for various reasons—perhaps due to employment leave or failure to keep copies of hardship documentation.

The IRS stipulates that electronic self-certification is not sufficient documentation of the nature of a participant’s hardship. Self-certification is permitted to show that a distribution was the only way to alleviate a hardship, but self-certification cannot show the nature of a hardship. Additional documentation must be requested and retained to show the nature of the hardship.

Questions on hardship distributions? Our Employee Benefit Plan Specialists can help.