Hardship Distributions: Source Documents vs. Documentation of Self-Certification by Participants

Posted by Maria T. Hurd, CPA

“The buck stops here” is a phrase that was popularized by U.S. President Harry S. Truman, who kept a sign with that phrase on his desk in the Oval Office. The phrase refers to the notion that the President has to make the decisions and accept the ultimate responsibility for those decisions.

When a plan sponsor engages a third-party administrator that agrees to authorize and distribute hardship distributions in accordance with the plan document and the Internal Revenue Code, that employer maintains the responsibility for plan transactions for which it did not actually see any supporting documentation. Determining who is ultimately responsible for maintaining the documentation, as well as how much self-certification from the hardship distribution recipient is permitted has been the source of great controversy in the industry.

On February 23, 2017, the IRS released a Memorandum to its agents setting forth the substantiation they should expect to see for 401(k) plan hardship distributions issued for the following safe-harbor definitions of an immediate and heavy financial need:

  1. Expenses for medical care deductible under section 213(d) for the employee or the employee’s spouse, children or dependents (as defined in section 152) or primary beneficiary under the plan;
  2. Costs directly related to the purchase of a principal residence;
  3. Payment of tuition, related educational fees, room and board expenses for up to the next 12 months of post-secondary education for the employee or the employee’s spouse, children or dependents (as defined in section 152) or primary beneficiary under the plan;
  4. Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure of the mortgage on that residence;
  5. Payments for burial or funeral expenses for the employee’s deceased parents, spouse, children or dependents (as defined in section 152) or primary beneficiary under the plan; or
  6. Expenses for the repair of damages to the employee’s principal residence that would qualify for the casualty deduction under section 165.

The IRS agents were instructed to examine source documents if they are obtained by the employer or third-party administrator, OR to examine the summary of documentation that the hardship distribution recipient will maintain, pursuant to a notification in the following format as outlined in in the attached document.

If the third-party administrator is obtaining a summary of the information contained in the source documents, it should provide a report or other access to this data to the employer at least annually, describing the hardship distributions made during the plan year.  The agent can always ask for the backup documentation in cases where there are inconsistencies in the documentation or multiple hardship distributions in one year, but for most situations, the process is clear, at least prospectively.

Hardship distributions issued in prior years should be reviewed to ensure that either the old rules or the new rules were followed.  Providers who believed participants could self-certify both the hardship reason and the need should ensure that the summary of the supporting documents and other procedures they obtained complied with all the requirements of the IRS Memorandum, including a certification by the participant that the information provided is true and accurate.  On the other hand, employers who were supposed to obtain documentation before approving hardship distributions, but didn’t, still have an operational violation and should consult with ERISA counsel or other appropriate service providers regarding their correction options. Lastly, distributions that do not meet the safe harbor definition of a hardship must still be substantiated by documentation proving the hardship event and a certification from the participant that they had no other way to meet the financial need.

At last, the controversy regarding the extent to which self-certification is permitted in the case of safe harbor hardship distributions, as well as how much of the approval process can legitimately be delegated to a third-party administrator is more clear thanks to this guidance. However, even with the more relaxed approach permitted in the Memorandum, the buck stops with the plan sponsor, who can never totally divest itself of its responsibility over plan operations, and should ensure that its service providers are in compliance with the procedures outlined in this Memorandum.

Photo by Phillip Taylor (License)

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