New IRS Guidance Addresses Hardship Distributions

The IRS recently published two pieces of guidance regarding documentation requirements for supporting proper safe harbor hardship distributions.

First, on February 23, in an internal memorandum, the IRS provided guidelines for its  employees who will examine whether a section 401(k) plan hardship distribution is “deemed to be on account of an immediate and heavy financial need” under safe-harbor standards. (Many 401(k) plans use the safe harbor hardship standards, under which a hardship distribution is “deemed to be on account of an immediate and heavy financial need” only if it is for one or more specific situations provided in IRS regulations (e.g., expenses for certain medical care). Plan sponsors – usually with the help of their advisors – must substantiate a participant’s or beneficiary’s claim that his or her requested hardship distribution is for one of those specific situations.)

To ensure that plan sponsors are complying with that substantiation requirement, this memorandum states that IRS plan examiners should perform the following steps:

• Step 1:  Determine whether the employer or third-party administrator, prior to making a hardship distribution, obtains source documents (e.g., invoices) or a summary of the information contained in source documents. If a summary of information on source documents is used, determine whether the employer or third-party administrator provides certain employee notifications listed in Attachment I of the memorandum before making a hardship distribution.
• Step 2:  If the employer or third-party administrator provides source documents under Step 1, the examiner should review the documents to determine if they substantiate the hardship distribution. If the employer or third-party administrator provides a summary of information on source documents under Step 1, the examiner should review the summary to determine if it contains relevant items listed on Attachment I of the memorandum. In certain cases, examiners should request source documents from the employer or third-party administrator. Also, if a third-party administrator obtains a summary of information contained in source documents under Step 1, the examiner should determine if the third-party administrator provides a report or other access to data to the employer, at least annually, that describes hardship distributions made during the applicable plan year.

This memorandum can be accessed via the following link:  https://www.irs.gov/pub/foia/ig/spder/tege-04-0217-0008.pdf

Second, on March 7, the IRS published an internal memorandum providing guidelines for its employees who will examine whether a section 403(b) plan hardship distribution is “deemed to be on account of an immediate and heavy financial need” under safe-harbor standards. IRS regulations provide that a hardship distribution for purposes of a 403(b) plan is subject to the rules that apply to 401(k) plans. Thus, this memorandum states that the above-referenced memorandum for 401(k) plans, and its Attachment I, also apply to hardship distributions from section 403(b) plans that are “deemed to be on account of an immediate and heavy financial need” under applicable IRS regulations. Here is a link to this memorandum:  https://www.irs.gov/pub/foia/ig/spder/tege-04-0317-0010.pdf