Hardships are distributions from the retirement plan that are made because of an immediate and heavy financial need in an amount that is commensurate with the corresponding need. For example, an employee may request a hardship withdrawal to pay for funeral expenses or medical expenses. And, keep in mind that unlike a loan from the plan, a hardship withdrawal doesn’t have to be paid back to the plan.
When an employee requests a hardship withdrawal from the plan, it is up to the plan sponsor (and often with the administrative assistance of the recordkeeper) to determine whether the hardship withdrawal is permitted. This determination by the plan sponsor is a fiduciary decision. The hard part about the hardship? The documentation.
Within the past six months, the Internal Revenue Service (IRS) has issued a series of guidance related to hardship withdrawals. In October 2016, the IRS updated its website - Hardship Distribution Tips from EP Exam – to remind plan sponsors that even though the law allows for hardships, the plan may not allow for the hardship. As such, plan sponsors are reminded that prior to approving the hardship, they should ensure the hardship is allowed (1) under applicable law and (2) under the plan document and adoption agreement.
In January 2017, the IRS updated an additional section of its website – It’s Up to Plan Sponsors to Track Loans, Hardship Distributions. Here, the IRS warned plan sponsors about the record retention requirements for demonstrating the nature of the hardship at issue. For example, it is not enough that an employee electronically self-certify their hardship on a recordkeeper’s website. Instead, the plan sponsor must review and retain documentation related to the nature of the hardship (for example, an estimate or invoice for the expenses that are the nature of the hardship).
Most recently, in February 2017, the IRS issued a memorandum to their employees who audit tax-qualified retirement plans, outlining the specific documentation that the examiner should seek in an audit of a plan. In addition to the specific categories of information to review, the IRS memo called-out two additional areas:
- Multiple hardship withdrawals. Recognizing that multiple hardships are legally permissible, the guidance identifies multiple hardships within a year as a red flag that requires adequate explanation and/or source documentation.
- Hardships administered by a third party. For plan sponsors that utilize a recordkeeper or other third party to administer hardships, the IRS wants to know if the plan sponsor is at least reviewing an annual report from the third party regarding the hardships during the year.
While the rules have not changed regarding hardships, the clarification around the rules may seem to make the documentation exercise more difficult. Plan Sponsors should consider the following action items with respect to hardships:
- Review the hardship provision(s) in your plan document;
- Review the IRS guidance related to hardship withdrawals (consider starting here); and
- Talk to your recordkeeper (or third party administrator, if applicable) about how they are assisting your plan with administration of hardship withdrawals and compliance with IRS regulations related to the same.
For additional information and to learn more about how this guidance specifically impacts your plan, reach out to your Multnomah Group Consultant.