Many 401(k) plans allow an employee to receive a distribution of elective contributions (employee deferrals) on account of a hardship (some plans also allow vested employer contributions to be distributed as well). Regulations require that a hardship distribution is made only if the employee has an immediate and heavy financial need and the distribution is necessary to satisfy that need. The regulations provide that certain safe harbor distributions will be deemed to meet the “immediate and heavy financial need” requirement (for example, deductible medical expenses). Many plans follow this safe harbor approach (which also requires an employee receiving a hardship distribution to suspend deferrals for six months).
Plans must substantiate that the distribution meets the requirements for the specific type of safe harbor distribution. Previously, the IRS said plan administrators should retain financial information and documentation to substantiate the need for a hardship distribution. That practice is still acceptable.
However, a new IRS memorandum also provides a simpler and perhaps less burdensome approach. Rather than retaining source documents, a plan administrator may retain a summary of information contained in them. To rely on such a summary, the employee obtaining a hardship distribution must be provided a notice containing information specified in the IRS memorandum, such as the tax consequences of a hardship distribution and the participant’s obligation to retain source documents relating to the hardship.
A summary must include general information about the hardship distribution, including the participant’s name, total cost of the event causing hardship, amount requested and a participant certification that the information provided is true and accurate. In addition, a summary must include basic information specific to the type of hardship distribution. For example, a summary for a hardship distribution for funeral and burial expenses must include the name of the deceased, the relationship to the participant, date of death, and the name and address of the service provider (i.e., cemetery or funeral home).
Plan administrators and record keepers may want to consider revising their hardship distribution procedures to conform with the guidelines in the IRS memorandum. The new guidelines may facilitate paperless applications for hardship distributions.