Hardship Distributions Burden of Proof

Published:

by Stacey L. Spencer, QKA | Manager, Employee Benefit Services Group

A hardship withdrawal allows emergency access to one’s 401(k) account balance. The key here is emergency access. Hardship withdrawals are only allowed for an immediate, pressing need, and only when all other means of obtaining funds have been exhausted. If the 401(k) plan also allows loans, the participant must first take all available loans prior to applying for a hardship distribution. Additionally, the hardship withdrawal can only be for the amount of the immediate financial need. One cannot request a hardship withdrawal in anticipation of a future need, even a continuing need such as mortgage payments or college tuition.

Hardship withdrawals are legally allowed if the participant meets the Internal Revenue Service criteria for having a financial �hardship� and if your 401(k) plan document allows for such a distribution (this is an optional provision).
The IRS safe harbor reasons for hardship withdrawal are as follows:

  • Payment of medical expenses not covered by insurance
  • Purchase of principal residence
  • Prevention of foreclosure or eviction from principal residence
  • Payment of tuition for postsecondary education for participant or dependents
  • Burial or funeral expenses
  • Damage to principal residence that would qualify for casualty deduction under Code Section 165.

It is important that the plan sponsor of the plan require proof of financial need before authorizing a hardship distribution from the plan. Simply relying on the reason that is checked on the hardship request is not enough. Proof may include copies of medical bills and insurance statements, past due notices from the landlord or mortgage company, copies of college tuition bills, etc. This proof should be retained by the plan sponsor in the event of an IRS audit. It is the plan sponsor�s responsibility to assure that there is a legitimate financial need.

As a plan sponsor, if you have any questions about the legitimacy of a hardship withdrawal request, you should contact your Third Party Administrator for advice.

If you would like assistance regarding hardship procedures, please give me a call.