401(k) Hardship Distributions

Atlanta companies offering a 401(K) or other benefit plan are faced with several challenges in plan management. The Internal Revenue Service (IRS) and Department of Labor (DOL) have several rules and regulations which must be followed to maintain compliance with the Employee Retirement Income Security Act (ERISA) of 1974. The purpose of these regulations is to ensure the plan operates in accordance with stated regulations and plan documents. While most maintain compliance, there are often questions that arise about plan operations and how to handle specific issues. A common topic we are asked about is hardship distributions. While complex, we have provided insight into the most frequently asked questions below.

What is a hardship distribution?

This is a special distribution taken from a 401(k) (or other plan types) to help the participant with an immediate and heavy financial need. The need can be directly attributed to the participant or be a need of the participant’s spouse, dependent, or in some cases non-spouse or non-dependent. A hardship distribution may not exceed the amount of the participant’s need but may include the amount needed to pay for penalties and taxes which may arise.

Only certain expenses qualify for a hardship distribution, including:

• Certain medical expenses,
• Costs relating to the purchase of a primary residence,
• Tuition and related fees,
• Burial or funeral expenses, and,
• Certain expenses related to the repair of the participant’s principal residence.

It’s important to note that even if an expense was foreseeable or voluntarily incurred, it may also qualify for a hardship distribution.

A distribution is not considered necessary if the participant has other resources available to resolve the debt. This includes assets of the spouse or dependents which can be used. How a plan sponsor determines if other resources are available is based on facts and circumstances and there are no hard and fast rules.  For example, if the participant (or spouse) owns a vacation home then this would typically be considered an available resource. However, property held for their child in a trust would not qualify.

In some plans, a participant may be required to exhaust all other options before requesting a hardship distribution. A plan sponsor may require a participant to take a plan loan before the request for additional assistance can be made.

How does a participant demonstrate need?

Since qualification requires the participant to demonstrate a need, it’s important to understand how they should do this. When an Atlanta 401(k) plan allows for hardship distributions, typically the plan documents will specify what information needs to be presented to qualify. However, most 401(k) plans use the “deemed necessary rule” (outlined above) to avoid making an inquiry into the participant’s financials.

Typically, the plan sponsor may rely on the participant’s representation they are experiencing a heavy and immediate need. However, this is not permitted if the sponsor has knowledge the participant’s needs can be relieved through other avenues including; insurance reimbursement, liquidation of assets, stopping elective contributions or other distribution options (plan loans, etc.).

What is the maximum distribution amount permitted?

In the past, the amount which could be taken from a 401(k) plan was restricted to the amount of elective deferrals and did not include any income earned on these amounts. However, plan sponsors have the option (but are not required) to allow elective and safe harbor contributions plus earnings, regardless of when they were made.

Are hardship distributions allowed for natural disasters?

Until recently there were no special hardship distributions permitted for natural disasters such as hurricanes or wildfires. However, recent changes have added a new expense to the qualifying list. Participants are now permitted to seek assistance with expenses related to natural disasters. This change is intended to eliminate any uncertainty about whether these events qualify and allow hardship distribution for natural disasters.

How are Hardship Distributions Taxed?

These distributions are subject to income taxes and may be subject to a 10% tax on early distributions. Participants who take a hardship distribution cannot repay it to the plan or roll it over to another plan.

Contact Us

Hardship distributions are an important feature of many 401(k) and other employee benefit plans. However, Atlanta plan sponsors need to carefully approach these requests to ensure distributions are made according to IRS and plan rules. If you have questions about hardship distributions or need assistance with a 401(k)-plan audit, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.