In a recent IRS Employee Plans News, the agency reminded employers to check the documentation employees provide before granting a hardship withdrawal from your plan. This caution likely stems from so many employers relying on their plan providers or third party administrators (TPA) to establish compliance processes and maintain adequate records. In fact, many of these records are inadequate, according to the IRS.
To avoid the headache of managing or administering a retirement plan, employers sometimes hire an outside plan provider or TPA. Herein lies the catch. While a plan provider may promise to handle everything for you, if you look at the contract or agreement that governs the relationship, you will probably find that you remain fully responsible to ensure administrative compliance and recordkeeping and that the TPA is merely following your directions. Essentially, it is your name and pocketbook on the line, not theirs. Be sure to carefully review these agreements with your ERISA counsel before signing. As some like to say, CYA, or Check Your Agreements carefully.
With that as a heads up, there is one particularly common and often misunderstood practice of which employers must be aware. Specifically, the IRS states that “IRS audits show that some TPAs allow participants to electronically self-certify that they satisfy the criteria to receive a hardship distribution. While self-certification is permitted to show that a distribution was the sole way to alleviate a hardship, self-certification is not allowed to show the nature of a hardship.”
Not obtaining proper evidence is a widespread practice that can cost the employer fines and penalties if not stopped and corrected retroactively. Even though the employee signs (self certifies) under penalty of perjury that the hardship is really for an authorized reason, this is not sufficient, and the IRS warns that it never has been. IRS Regulations 1.401(k)-1(d)(3)(iv)(C) and (D) require the employer to request and retain documentation to show the nature of the hardship. Failure to do so is a plan violation for which fees and penalties may be assessed.
For each hardship withdrawal, the employer must request and retain (or ensure that their provider or TPA is properly obtaining) the following documents in either paper or electronic format:
- Documentation of the hardship request, review, and approval;
- Financial information and documentation that substantiates the employee’s immediate and heavy financial need;
- Documentation to support that the hardship distribution was properly made in accordance with the applicable plan provisions and the Code; and
- Proof of the actual distribution made and related Forms 1099-R.
Should you discover that your provider does not have adequate documentation for each hardship withdrawal, your plan may be subject to disqualification unless you make a voluntary correction prior to being audited. To obtain IRS Employee Plan News bulletins, simply Google the term and you will be taken directly to the website.