Substantiation Requirement Clarified for Examination Purposes
Over the past few years, employers and plan administrators have frequently asked how hardship withdrawal requests can/should be substantiated from 401(k) and 403(b) plans and, in particular, whether self-certification is sufficient. The Internal Revenue Service (“IRS”) has answered this by affirming plan sponsors’ obligation to obtain substantiation that a participant has experienced an immediate and heavy financial need before granting a participant’s request for a hardship withdrawal. See, for example, the April 15, 2015 edition of “Employee Plan News” found here. However, on February 23, 2017, the IRS issued a memorandum providing Employee Plans examiners with guidance on evaluating whether a plan’s participants have sufficiently substantiated that their request for a hardship withdrawal is on account of an immediate and heavy financial need, which appears to bless one alternative to obtaining source documentation.
Refresher: What events are deemed to constitute an immediate and heavy financial need?
• Expenses for medical care for the employee or spouse, children or dependents, or primary beneficiary under the plan,
• Costs directly related to the purchase of a primary residence,
• Payment of tuition, related educational fees, or 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, or primary beneficiary under the plan,
• Payments necessary to prevent the eviction of the employee form the employee’s principal residence or foreclosure of the mortgage on that residence,
• Payments for burial or funeral expenses for the employee’s deceased parents, spouse, children or dependents, or primary beneficiary under the plan, or
• Expenses for the repair of damages to an employee’s principal residence that would qualify for the casualty deduction under Section 165.
The memorandum is not a pronouncement of law and cannot be relied on as such, but it provides insight as to how an IRS examiner will evaluate this aspect of a plan’s hardship withdrawal program.
New Notice and Summary Approach
The memorandum sets forth a series of steps for the IRS examiner to follow when determining whether a plan’s hardship withdrawal is making distributions on account of a deemed immediate and heavy financial need. In short, the employer or third party administrator (“TPA”) can either request source documents, or provide participants with a notice and ask certain questions (which vary depending on the reason for seeking the hardship withdrawal) that summarize the information in the source documents without obtaining the actual source documentation itself. The elements of the notice, as well as the required questions, are found in Attachment I on pages 3 and 4 of the memorandum. While the employer or TPA is not required to obtain the source documentation under the alternative notice and summary approach, the participant must agree to keep and produce upon request records of the event. If the examiner finds that the responses to the summary questions are internally inconsistent, or that participants are receiving more than two hardship withdrawals in a year without adequate explanation, the examiner can request the source documentation. If the hardship withdrawal program is being administered by a TPA, the TPA must provide the employer a report at least annually summarizing the hardship withdrawals made in the plan year.
Substantiating hardship withdrawals has long been a pain point for employers and plan administrators, and this memorandum, while not official guidance, is a welcome glimpse into the IRS’s view of what might be acceptable in lieu of obtaining actual documentation upfront. While this is a very welcome development, employers/TPAs should consider whether they prefer to continue requesting source documentation or align their programs with the memorandum. A possible risk with the alternative approach is the participant misplacing or being otherwise unable to produce the source documentation if requested. Responsibility would still seem to lie with the employer to demonstrate it has a compliant hardship withdrawal program, and given the IRS’s past guidance stressing the importance of substantiating withdrawals, it remains to be seen how examiners will react to situations where the documentation is needed but not available.