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Case of the Week: Is Electronic Documentation Adequate for Hardship Distributions?

The ERISA consultants at the Learning Center Resource Desk, which is available through Columbia Threadneedle Investments, regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with an advisor in Oregon is representative of a common inquiry regarding hardship distributions from 401(k) plans. The advisor asked:

“During a recent IRS examination of a 401(k) plan, a plan sponsor was told that e-certification for hardship distribution is inadequate. Do you have any guidance on what is required?”

Discussion


  • The plan sponsor is ultimately responsible for the proper administration of hardship distributions, including the responsibility to maintain records of such distributions. While the IRS has indicated that plan sponsors (or their third party administrators) can store these records in paper or electronic format, there are specific elements of the hardship distribution that cannot be satisfied electronically.

  • For example, electronic self-certification by the plan participant is not sufficient documentation of the nature of a participant’s hardship.

  • Under 401(k) regulations, hardship distributions must meet a two-prong test: (1) the participant is experiencing an immediate and heavy financial need; and (2) the distribution is necessary to satisfy that immediate and heavy financial need.

  • IRS exams have shows that some TPAs allow participants to electronically self-certify that they satisfy the criteria to receive a hardship distribution. While self-certification is permitted to show that a distribution was the sole way to alleviate a hardship (item #2 above), self-certification is not allowed to show the nature of a hardship (item #1 above). (See Treasury Regulation Sections 1.401(k)-1(d)(3)(iv)(C) and (D).) For this purpose, plan sponsors must request and retain additional documentation to show the nature of the hardship.

  • According to tips from IRS exam agents on hardship distributions, agents will look for documentation that the plan sponsor confirmed that: (1) the employee requesting the hardship had exhausted other permitted plan distributions, such as loans; and (2) the hardship distribution didn’t exceed the amount necessary to satisfy the participant’s immediate and heavy financial need. According to the IRS: "There's a growing trend for plans to grant hardships to participants who electronically apply for them. Participants use their PIN and self-certify that they meet the hardship criteria. While this seems to be an easy process for the participant, enabling them to quickly receive their distribution, this process doesn’t relieve the plan sponsor’s need for verification and recordkeeping. The agent will still look for the same documentation mentioned above to ensure that the plan made hardship distributions according to its terms and the law."


Conclusion

Plan sponsors are responsible for the proper administration of hardship distributions, including the responsibility to maintain records of such distributions. While participant self-certification is permitted to show that a distribution was the sole way to alleviate a hardship, self-certification is not allowed to show the nature of a hardship. Plan sponsors must retain documentation that confirms: (1) the employee requesting the hardship had exhausted other permitted plan distributions; and (2) the hardship distribution didn’t exceed the amount necessary to satisfy the participant’s immediate and heavy financial need.

The Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC (RLC), a third-party industry consultant that is not affiliated with Columbia Threadneedle. Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Columbia Threadneedle does not provide tax or legal advice. Consumers consult with their tax advisor or attorney regarding their specific situation.
Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Columbia Threadneedle.
Columbia Threadneedle Investments (Columbia Threadneedle) is the global brand name of the Columbia and Threadneedle group of companies.

©2016 Columbia Management Investment Advisers, LLC. Used with permission.

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