Contributing Author: Kristine M. Custodio, Advanced Certified Paralegal
Are you following the best practices when it comes to your employees' 401(k) safe-harbor hardship distributions? Should your 401(k) plan ever come under audit by the Internal Revenue Service, your documentation will be critical to a swift resolution of the examination. In general, the following are best practices which can also serve as a helpful checklist for tracking 401(k) safe-harbor hardship distributions:
1. Are you providing proper notice to your employees taking 401(k) safe-harbor hardship distributions?
Generally, the following information should be provided by the employer to the employee related to hardship withdrawals:
- The hardship distribution is taxable and additional taxes could apply.
- The amount of the distribution cannot exceed the immediate and heavy financial need.
- Hardship distributions cannot be made from earnings on elective contributions or from qualified nonelective contribution (QNEC) or qualified matching contributions (QMAC) accounts, if applicable.
- The recipient agrees to preserve source documents and to make them available at any time, upon request, to the employer or administrator.
2. Are you keeping proper documentation related to all hardship requests?
The proper documentation should include the following:
- Participant's name
- Total cost of the event causing hardship (for example, total cost of medical care, total cost of funeral/burial expenses, payment needed to avoid foreclosure or eviction)
- Amount of distribution requested
- Certification by the participant that the information provided is true and accurate
3. Are your employees taking 401(k) safe-harbor hardship distributions that constitute deemed hardships?
Whether a need is immediate and heavy depends on the facts and circumstances. However, certain expenses are deemed to be immediate and heavy, including:
- Medical Care: Expenses for medical care are deductible under section 213(d) for the employee or the employee's spouse, children or dependents (as defined in section 152) or primary beneficiary under the plan;
- Purchase of Principal Residence: Costs directly related to the purchase of a principal residence;
- Educational Payments: Payment of tuition, related educational fees, room and board expenses for up to the next 12 months of post-secondary education for the employee or the employee's spouse, children or dependents (as defined in section 152) or primary beneficiary under the plan;
- Foreclosure/Eviction from Principal Residence: Payments necessary to prevent the eviction of the employee from the employee's principal residence or foreclosure of the mortgage on that residence;
- Funeral and Burial Expenses: Payments for burial or funeral expenses for the employee's deceased parents, spouse, children or dependents (as defined in section 152) or primary beneficiary under the plan; or
- Repairs for Damage to Principal Residence: Expenses for the repair of damages to the employee's principal residence that would qualify for the casualty deduction under section 165.
If you have questions about hardship withdrawals, contact the attorneys at Butterfield Schechter LLP for more information about the options available to you.