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IRS Updates Info on Hardship Distributions, Corrections

The IRS has updated the information it makes available on its website concerning hardship distributions, as well as making corrections regarding not only those distributions but also other aspects of plan administration.

Hardship Distributions

A retirement plan may, but is not required, to allow such distributions. They can be made if the distribution is due to an immediate and heavy financial need and is limited to the amount necessary to satisfy that need.

A distribution is automatically considered to be necessary to satisfy such a need if all of the following requirements are met:

  • the distribution isn't greater than the amount of the need, including the amounts necessary to pay any taxes resulting from the distribution;

  • the employee has obtained all other currently available distributions (including distribution of ESOP dividends under section 404(k), but not hardship distributions) and nontaxable (at the time of the loan) plan loans, including all other plans maintained by the employer; and

  • the employee isn't allowed to make elective deferrals to the plan for at least six months after the hardship distribution.

The IRS also reminds that under a safe harbor in IRS regulations, an employee is automatically considered to have an immediate and heavy financial need if the distribution is for any of these:

  • medical care expenses for the employee, the employee’s spouse, dependents or beneficiary;

  • costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments);

  • tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents or beneficiary;

  • payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence;

  • funeral expenses for the employee, the employee’s spouse, children, dependents or beneficiary; and

  • certain expenses to repair damage to the employee’s principal residence.

The IRS notes in its information on hardship distributions that the most common errors made, and the way to correct them, are the following:

Plan document doesn’t permit hardship distributions. Plan sponsors may correct the operational failure of making hardship distributions to employees under a plan that doesn’t have hardship distribution language using the plan amendment correction method.

Hardship distribution for a reason not allowed by the plan. If the plan language allows hardship distributions only under specific circumstances, the plan can’t be more liberal than the language allows. Remember that if a plan sponsor decides to be more liberal in how it defines what constitutes a hardship, then the plan sponsor must prospectively amend their plan.

Failing to suspend participant salary deferrals. If plan terms require an employee to be suspended from contributing to the plan making the distribution and all other employer plans for at least six months after receiving a hardship distribution, and the plan fails to do this, there are two ways to correct the effort options:

1. Suspend the employee from making salary deferrals for a six month period going forward.
2. The employee could return the hardship distribution (adjusted for earnings) to the plan.

The IRS also has updated the information it provides concerning the voluntary correction program (VCP). The VCP is one of three correction programs you can use to correct errors under the Employee Plans Compliance Resolution System (EPCRS). The other two EPRCS programs are the Self-Correction Program (SCP) and the Audit Closing Agreement Program (Audit CAP).