By Jenny Kiffmeyer, J.D – The Retirement Learning Center
Hardship Distribution Certification
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with a financial advisor in Rhode Island is representative of a common inquiry related to hardship distributions.
The advisor asked: “I’m working with a third-party administrator that had a question concerning hardship distributions from 401(k) plans. Is source documentation (e.g., proof of medical bills) required to process a hardship distribution.”
This seemingly simple question is not as clear as it may seem on account of the SECURE Act 2.0 changes to the hardship rules juxtaposed with current IRS audit guidelines. Let’s explore the rules to better understand the issues at hand.
Under the original hardship distribution rules and assuming a plan permits hardship withdrawals, a hardship distribution must meet three conditions, generally. These include the following:
- There is an immediate and heavy financial need,
- The amount of the distribution request does not exceed the amount required to meet the need, and
- The participant does not have other assets reasonably available to meet this need.
The IRS has identified a number of “safe harbor” situations that are deemed to meet the first requirement [see Treasury Regulation 1.401(k)-1(d)(3)(iii)(B)]. In recent years, if the plan follows the safe harbor definitions of hardship, then a participant could self-certify the second and third requirements above, but the plan was required to substantiate the first requirement—that a distribution is for one of the safe harbor events that constitute an immediate and heavy financial need.
SECURE Act 2.0 expanded the self-certification to include all three requirements. Plan sponsors can rely on a participant’s self-certification unless it has actual knowledge to the contrary.
Despite the SECURE Act 2.0 expansion of self-certification, the current IRS guidance audit guidelines still reflect that source documentation for the hardship be available to the auditor. (See Substantiation Guidelines for Safe-Harbor Hardship Distributions from Section 401(k) Plans.)
Until additional guidance becomes available from IRS, it is possible an IRS auditor (or a plan auditor for Form 5500 filing purposes) would still request source documentation supporting the hardship claim.
Another consideration is plan language. Despite the SECURE Act 2.0 liberalization of the hardship self-certification rules, some plan sponsors may wish to retain control over the hardship process. Also, some plans may not rely on the deemed safe harbor hardship events and rely on the facts and circumstances test. Consequently, plan language will ultimately control the approach used in hardship determinations.
Until the IRS provides additional audit guidance under the new hardship rules, plan sponsors should consult with their record keepers, TPAs and legal counsel to determine the best approach in dealing with hardship distribution requests and set a clear policy.
