Proper administration and record keeping will keep your plan in compliance.
By Jake Dopson, assurance senior manager, CPA, CCIFP
The administration of your Company’s 401(k) or 403(b) defined contribution employee benefit plan is often a thankless task that is delegated to payroll or accounting clerks that may or may not be familiar with all the regulations surrounding such a task. Unfortunately, non-compliance with Department of Labor, Internal Revenue Service (IRS), or Employee Retirement Income Security Act (ERISA) regulations can mean a big headache to companies, both administratively and financially. One such area that is susceptible to error is hardship distributions.
Hardship distributions from defined contribution plans are in-service distributions taken by a plan participant of their vested plan dollars for the purpose of covering an immediate and heavy financial need of the participant, or the participant’s spouse or dependent. Unlike participant loans, hardship distributions are not required to be paid back to the plan. Also unlike participant loans, hardship distributions are subject to income tax and a 10% early withdrawal penalty if the participant receiving the distribution has not reached the current retirement age as defined by the IRS.
The first step to administering hardship distributions within a defined contribution plan is to determine whether the plan allows for such transactions in the first place. Plan sponsors may elect to not allow hardship distributions, or may elect to allow only hardship distributions that meet specific criteria. In general, a simple review of a the Plan Document, which details the Plan’s terms and conditions related to the operation and administration of a plan, will reveal whether hardship distributions are allowed by a plan.
For plans that allow hardship distributions, it is important for plan administrators to understand what kind of expenses meet the “hardship” criteria, as defined by the IRS. These expenses include: 1) certain medical expenses, 2) costs relating to the purchase of a principal residence, 3) tuition and related educational fees and expenses, 4) payments necessary to prevent eviction from or foreclosure on a principal residence, 5) burial or funeral expenses, and 6) certain expenses for the repair of damage to the participant’s principal residence. Such expenses must also qualify as necessary to satisfy an immediate and heavy financial need of the participant. If the participant has other available assets or resources, a hardship distribution would not be allowed, regardless of the nature of the expense.
Plan administrators should create a consistent process to document hardship distributions. This would include requiring the participant requesting the distribution to complete and request form and provide documentation to support the criteria for a hardship distribution, as defined above. All such forms and documentation should be kept with plan documents as support for plan transactions. Plan administrators also need to be aware that participants who receive a hardship distribution are not allowed to make elective employee contributions to the plan for a minimum of 6 months after the receipt of the hardship distribution.
By understanding the rules, regulations and definitions surrounding hardship distributions, as well as creating sound procedures for administering such transactions, plan administrators should be able to keep their defined contribution plans in compliance with all applicable parties.
For more information on how your company can achieve better results, contact the team at Pulakos CPAs – where Performance Matters™!