Financial hardship? Your retirement plan is an option

Employers often offer their employees a retirement plan as a part of their benefits package. Since these funds are to be invested for use upon retirement, they are largely untouchable until later in life.

However, sometimes real life gets in the way of a well-laid plan.

The IRS does make provisions for early distributions from 401(k) or 403(b) plans for reasons of financial hardship. However, employees seeking early withdrawal of their funds must provide the plan administrator written documentation justifying the need for the early distribution. Generally, employees must provide original documents. New instructions to auditors, however, ease that requirement by allowing plan administrators to present auditors a summary of the employee’s hardship circumstances.

The following is a look at expenses that qualify for hardship distribution and the information needed from the employee:

Medical care of employee, spouse or dependent

  • Total cost of the care
  • Who incurred the expenses and their relationship to the employee
  • The purpose of the medical care (e.g., diagnosis, treatment, prevention);
  • The name of the hospital or doctor;
  • The expenses not covered by insurance.

Purchase of principal residence

  • Whether this is the employee’s principal residence;
  • The address;
  • The purchase price;
  • The type of costs and expenses covered;
  • The lender’s name and address;
  • The date of the purchase agreement; and
  • The expected closing date.

Tuition for post-secondary education (one full year’s payment for employee, spouse or dependent)

  • The student’s name and relationship to the employee;
  • The school’s name and address;
  • The categories of payments (e.g., tuition, room, board); and
  • The period covered by the payments.

Foreclosure/eviction on employee’s principal residence

  • Whether this is the employee’s principal residence;
  • The address;
  • The type and date of the event (foreclosure or eviction); and
  • The due date of a payment to avoid foreclosure or eviction.

Funeral/burial expenses for employee, parent or other dependent

  • The name of the deceased and the deceased’s relationship to the employee;
  • The date of the death; and
  • The name and address of the service provider (e.g., cemetery, funeral home, etc.).

Certain repairs to a principal residence that qualify for the casualty loss deduction

  • Whether this is the employee’s principal residence;
  • The address; and
  • Brief description of the casualty and repairs.

While the IRS still recommends retaining original documents – estimates, contracts, bills and statements from third parties that back up the employee’s immediate need – plan administrators are permitted to create a summary of information from those source documents.

To pass muster with auditors, though, the summaries must show that the plan administrator advised the employee before the distributions were made of the following:

  • The distributions are taxable and additional taxes could apply;
  • The distributions cannot exceed the immediate financial need they are going to be used to cover;
  • Distributions cannot be made from any employer matching contributions; and
  • The employee must retain his or her original documents.

Employees should also be aware that hardship distributions are subject to mandatory 10 percent withholding unless they opt out on Form W-4P. They also may not make any pretax or after-tax contributions for at least six months after they receive their money.

Please let us know if you have any questions.

Source: Payroll Legal Alert

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