Hardship Distribution Tips For You and Your Plan Participants
Monika Templeman, Director of EP Examinations, responds to questions and offers insights on retirement plan topics uncovered during audits. You may provide feedback or suggest future topics by emailing her at: RetirementPlanComments@irs.gov.
I want to give employers who offer hardship distributions in their retirement plans some tips to keep their plans in compliance. Employers and plan participants are often confused by hardship distributions rules. These tips will help them both better understand hardship distribution requirements.
Definition of a hardship – reminders for plan sponsors
To receive a hardship distribution, a plan participant must have an “immediate and heavy financial need,” and the hardship distribution can only be for the amount necessary to satisfy that need. The IRS regulations give some qualifying situations for hardships, including:
- medical expenses for you, your spouse, dependents or beneficiary;
- costs directly related to the purchase of your main home (excluding mortgage payments);
- tuition, related educational fees including room and board expenses for the next 12 months of postsecondary education for you, your spouse, children, dependents or beneficiary;
- payments necessary to prevent eviction from your main home or foreclosure on the mortgage on that home;
- funeral expenses for you, your spouse, children, dependents or beneficiary; and
- certain expenses to repair damage to your main home.
You, the plan sponsor, can avoid hardship distribution errors simply by following the plan language. Please remember that plan language must specifically describe the criteria and situations in which the plan may make a hardship distribution. In addition, it’s important to keep documentation to substantiate a participant’s reason for the hardship.
We find many errors in applying the hardship rules, including making hardship distributions when the plan document doesn’t allow them. Fortunately, plan sponsors can correct this error under the Self-Correction Program by adopting a retroactive amendment to their plan to allow hardship distributions.
Applying for a hardship distribution – tips for participants
If you, the plan participant, have a financial need that requires a hardship distribution from your retirement plan, you must submit an application. Some employers require a paper application and others use electronic applications. Either way, participants should submit the following documentation with their request:
- Written representation of the hardship. In an electronic application, you may just have to check a box from a list of plan-approved hardship reasons. It’s still important to keep all paperwork in case your employer needs to see it. For example, if you receive an eviction notice from your landlord or mortgage holder, make a copy for your hardship distribution request.
- The amount necessary to cover your hardship. Calculate the amount you need to relieve the hardship. Your employer needs to know the amount to determine if it’s reasonable. Remember, you must pay income taxes on any previously untaxed amount of your hardship distribution, and you may have to pay an additional 10% tax on early distributions unless you qualify for an exception. You’re permitted to include your estimated federal, state, local and early distribution taxes in the amount of your hardship request.
- Written representation that you can’t relieve the hardship through other resources. The hardship distribution request will ask for a written statement or other verification that you have no other means to satisfy your hardship. Examples of other resources include plan loans, commercial loans, insurance, asset liquidation and discontinuing plan elective deferrals. If the plan allows loans, it may require you to take a plan loan first before receiving a hardship distribution.
However, you aren’t required to take counterproductive actions. For example, if taking a plan loan to purchase a main home disqualifies you from obtaining other financing, then the loan is not a reasonable means to satisfy your hardship.
Remember that hardship distributions should be a last resort. These distributions can’t be repaid; they’re a permanent reduction in your retirement account. If you must take a hardship distribution from your plan, understanding your plan document and the hardship rules will help both the employer and employee with these distributions.