Life can present unexpected challenges that can catch even the most well prepared off guard.

In such situations, it may be necessary to obtain more cash than one may have to address the problem. When this happens, individuals often turn to their 401k plan as a money source during the difficult period. The good news is that the IRS permits hardship distributions designed to help individuals in such situations. There are specific rules and regulations which must be followed by the employer when such requests are made. According to the IRS, a hardship distribution can be made when a participant has an “immediate and heavy financial need”. Proof that other funds cannot be accessed to address the issue may also be required. Examples of an immediate and heavy need include medical expenses, funeral expenses and payments necessary to prevent eviction. It’s the responsibility of the employer to ensure compliance with these rules. Unfortunately, this is where many employers run into problems leading to an improper hardship distribution. To help clients, prospects and others understand how to correct such an error, Hanson & Co has provided a summary of correction steps to take below.

Common Hardship Distribution Errors

One key challenge that employers must overcome in the determination process is identifying if there is a qualifying need. According to the IRS, the following qualify for a hardship distribution:

  • Medical expenses generated by the employee, their spouse or any dependents

  • Costs directly related to the purchase of the employee’s primary principal residence (excluding mortgage payments)

  • The cost of tuition, educational fees, room and board expenses for the next 12 months of post-secondary education for the employee, their spouse or dependents

  • Payments necessary to prevent the eviction of the employee from their principal residence or to avoid foreclosure

In other situations, an error can occur when a plan sponsor allows participants to take distributions for hardship purposes without realizing there is no provision for it in the plan documents or the plan doesn’t specifically state when hardship distributions can be made. In addition, if the plan requires salary deferral suspension after a hardship distribution is made, but the plan sponsor fails to do so, corrective action must be taken.

Corrective Action

If any of these situations, it may be necessary to adopt a retroactive plan amendment that corrects the error(s) by using the plan amendment correction method. Retroactive plan amendments are effective January 1 of the year in which the violations occurred. It’s important to note that the amendment must specify that the hardship distribution option is non-discriminatory.

If distributions were made to participants that didn’t meet 401(k) hardship distribution rules, a correction may involve repayment to the plan of the amount that didn’t meet requirements. In most cases, this will require the participant to return the distribution plus estimated earnings the money would have earned had it remained in the plan.

Contact Us

There are many unique situations that employers will face in the administration of their 401(k) or another retirement plan. From time to time errors will be made that require correction with the IRS or other regulatory agencies. If you have questions about hardship distribution rules, need help taking corrective action on an error or need assistance with your 401k plan audit, Hanson & Co can help. For additional information please call us at (303) 388-1010, or click here to contact us. We look forward to speaking with you soon