Substantiating 401(K) Hardship Distributions – What Do I Have To Prove?

Many 401(k) plans provide that an employee participant can receive a distribution of his or her elective deferrals from the plan on account of a financial hardship. A hardship distribution is only permitted if the employee experiences an immediate and heavy financial need and the distribution is required to satisfy that need. An immediate and heavy financial is defined by the IRS as one or more of the following with respect to the employee or the employee’s immediate family: (i) medical expenses; (ii) purchase of a principal residence (employee only); (iii) tuition and related educational expenses; (iv) payment necessary to prevent an eviction or foreclosure of a principal residence; (v) burial expenses; and (vi) repair expenses for damage to the employee’s principal residence.

A big issue for sponsors of 401(k) plans is what substantiation is needed to document that the conditions for a hardship distribution are met. The IRS recently updated their Internal Revenue Manual to provide guidance for their auditors regarding examinations (audits) of qualified plans with respect to hardship distributions. The list above is merely a summary. The IRS has provided a detailed memorandum of what documentation is required (see IRS Memorandum). Although the memorandum is not official guidance and does not create a safe harbor for 401(k) plans, it is helpful in establishing procedures with respect to hardship distribution requests from employees. If you do have questions, please contact me at gremer@hertzshram.com.