In its summer edition of Retirement News for Employers, the Internal Revenue Service (“IRS”) provided seven recommended steps that plan sponsors should follow before making a hardship distribution from a qualified retirement plan (401(k)):
Step 1 Review the terms of the plan, including: (1) whether the plan permits hardship distributions; (2) the procedures to request a hardship distribution; (3) the plan’s definition of hardship and (4) the limits on the type and amount of distributions.
Step 2 Ensure that the employee complies with the plan’s procedural requirements, making sure the employee provides a statement or verification of his or her financial need.
Step 3 Verify that the employee’s specific reason qualifies for a distribution, using the plan’s definition of what constitutes a hardship.
Step 4 If the plan offers loans, document that the employee has exhausted them prior to receiving a hardship distribution.
Step 5 Check that the amount of the hardship distribution does not exceed the amount necessary to satisfy the employee’s need. The amount required to satisfy the financial need may include amounts necessary to pay any penalties or taxes that are due because of the hardship distribution.
Step 6 Make sure that the amount of the hardship distribution does not exceed any limits under the plan and is made only from amounts eligible for a hardship distribution.
Step 7 Most plans also specify that the employee is suspended from contributing to the plan for at least 6 months after receiving a hardship distribution. Employers must inform employees of this provision and enforce it. Failure to cease contributions is a common error that must be corrected the Employee Plans Compliance Resolution System (“EPCRS”).