When an employee requests a hardship deduction, it can seem to be a great deal of work for an employer. Recent changes requiring more specific substantiation will go into effect on February 23, 2019.
Use these three steps as a quick guide to ensure you are meeting your responsibility as an employer.
Step 1: Ensure the 401(k) plan has language that includes hardship distributions. (If it does not, see here how to make changes.)
Step 2: Determine if the hardship of the employee fits the definition of a hardship.
A hardship, as defined by the IRS is “made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need.”
The need can be one of the following (for employee, spouse, dependents or non-dependent beneficiaries):
- Certain medical expenses
- Costs related to buying a principal residence
- Tuition and related educational fees
- Payments necessary to prevent eviction or foreclosure on principal residence
- Burial or funeral expenses (for employee’s deceased parents as well)
- Certain expenses caused by damage to a primary residence
Once these two criteria are met, you can use this simple checklist to complete the process:
Step 3: Checklist
- Notify the employee
- Hardship is taxable
- Distribution amount cannot exceed cost of hardship
- All records related to the distribution must be kept and available
- Collect general information
- Amount requested
- Certification of truth and accuracy of information
- Gather the specific documents listed HERE
- Ensure documentation substantiates the hardship distribution
- Determine if the employee has taken advantage of the hardship distributions in the past
- Has the employee received more than 2 hardship distributions in a plan year?
- If yes, did they have an adequate explanation?
- If no, request more documentation on past distributions
- Clarify that the employee has no other financial means of alleviating the hardship
- Check the amount distributed is not greater than the financial need of the hardship
- Keep a record of all information used to determine if the employee was eligible for the hardship
For more detail on the recent changes to the hardship distribution rules, click here.
Find other do’s and don’ts of hardship distributions here.