United States

IRS permits self-certification for safe-harbor hardship distributions

FINANCIAL REPORTING INSIGHTS  | 

Under IRS regulations, defined contribution plans may permit a participant to withdraw certain retirement plan funds while employed if the participant has an immediate and heavy financial need. The regulations allow plans to either (a) establish their own criteria for what constitutes an immediate and heavy financial need or (b) allow hardship distributions only for certain events specified in the regulations, which are deemed to automatically satisfy the requirements of immediate and heavy financial need (referred to as the “safe harbor” hardship withdrawal events). The safe harbor hardship events are:

  • Medical care expenses for the employee, the employee’s spouse, dependents or beneficiary
  • Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments)
  • Tuition, related educational fees and room and board expenses for the next 12 months of post-secondary education for the employee or the employee’s spouse, children, dependents or beneficiary
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence
  • Funeral expenses for the employee, the employee’s spouse, children, dependents or beneficiary
  • Certain expenses to repair damage to the employee’s principal residence.

IRS regulations do not provide guidance as to the process plan sponsors must follow to verify that an immediate and heavy financial need actually has arisen, but a 2015 IRS newsletter stated that electronic self-certification was not sufficient to document a participant’s financial hardship. This lack of authoritative guidance has led to various substantiation approaches by plan sponsors and third-party administrators. Two recent IRS memorandums provide guidance on plan participant hardship distribution substantiation requirements.

On February 23, 2017, the IRS issued a memorandum to employee plans examination employees the subject of which was Substantiation Guidelines for Safe-Harbor Hardship Distributions from Section 401(k) Plans (the “401(k) Memorandum”). The 401(k) Memorandum states that a summary of information provided by a 401(k) plan participant to the employer or a third-party administrator could be used to substantiate a safe-harbor hardship distribution deemed to be on account of an immediate and heavy financial need. An attachment to the 401(k) Memorandum provides a list of information that is required for the summary of information for each of the deemed hardship events. The memo also states that the employer or third-party administrator needs to provide certain notifications to the participant prior to making a hardship distribution.

On March 7, 2017, the IRS issued a second memorandum to employee plans examinations employees the subject of which was Substantiation Guidelines for Safe-Harbor Hardship Distributions from Section 403(b) Plans. The memo states that if, during an examination of a 403(b) plan, the examiner determines that all applicable requirements in the 401(k) Memorandum are satisfied, the section 403(b) plan should be treated as satisfying the substantiation requirements for making hardship distributions deemed to be on account of an immediate and heavy financial need.

Many plans modified their procedures to obtain and retain the supporting information for a hardship distribution in light of the 2015 IRS position. The new guidance does not require that these plans revise their procedures. To the extent that such plans find their revised procedures burdensome or time consuming, relief may be available under the updated guidance. For plans that continue to rely solely on their service provider or the participants to maintain the evidence supporting a hardship distribution, we recommend they review their procedures in light of this new information.