On February 23, 2017, the Acting Director of the IRS's Employee Plans Examinations unit issued a memorandum to EP Examination employees that sets forth certain substantiation guidelines that such employees should follow when determining whether a 401(k) hardship distribution is to be "deemed on account of an immediate and heavy financial need," under the safe-harbor regulations.
Many 401(k) plans permit employees to receive a distribution of their elective deferrals if the distribution is required to meet the employee's immediate and heavy financial need. In accordance with the regulations, a distribution is deemed to be for an immediate and heavy financial need if it is provided for one or more of the following six reasons: (1) expenses for medical care deductible under section 213(d), (2) costs related to the purchase of a principal residence, (3) payment of tuition and room and board expenses for up to the next 12 months of post-secondary education, (4) payment necessary to prevent the eviction of employee from principal residence or the foreclosure of the mortgage on a principal residence, (5) payments for burial expenses, and (6) expenses for repair of damages to the principal that would qualify as a casualty deduction under section 165.
The memorandum instructs the Employee Plans Examiner personnel to follow a two-step process in order to determine if a distribution was actually made for one of the six immediate and heavy financial needs noted above. In order to meet the substantiation requirements for making a hardship distribution on account of an immediate and heavy financial need, the plan examiner must find that both Step 1 and Step 2 are satisfied. To view the memorandum and view Step 1 and Step 2, click here.
Although the IRS's internal memorandum does not have the force of law, by understanding how the IRS will analyze a plan sponsor's hardship withdrawal substantiation process, plan sponsors should be able to improve their compliance posture. We recommend that plan sponsors print the IRS memorandum and place a copy in their plan document binder near the hardship withdrawal section for future reference. Should you have any questions, please call your relationship attorney.