IRS Stresses Plan Sponsor Role in Tracking Loans, Hardship Distributions
The IRS has updated a reminder that plan sponsors ultimately are responsible for tracking plan loans and hardship distributions. The reminder was included in the IRS’ Employee Plans Newsletter, Issue Number 2015-4, dated April 1.
The reason, says the IRS, is that a plan sponsor bears the ultimate responsibility for administering a retirement plan — even if a third party administrator (TPA) handles participant transactions.
The IRS stresses that it is especially important that a plan sponsor keep documentation regarding hardship distributions and plan loans.
A plan sponsor must obtain and keep records of hardship distributions. The IRS warns that it is insufficient for plan participants to keep their own records of hardship distributions. For instance, the IRS points out, participants may leave employment with that particular employer or fail to keep copies of hardship documentation, making their records inaccessible in an IRS audit.
The IRS also cautions that electronic self-certification by a plan participant is not sufficient documentation of the nature of a participant’s hardship. 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 cannot be used to show the nature of a hardship. A plan sponsor must request and retain additional documentation to show the nature of the hardship.
The IRS advises that a plan sponsor retain the following records in paper or electronic format:
1. documentation of the hardship request, review and approval;
2. financial information and documentation that substantiates the employee’s immediate and heavy financial need;
3. documentation to support that the hardship distribution was properly made in accordance with the applicable plan provisions and the Internal Revenue Code; and
4. proof of the actual distribution made and related Forms 1099-R.
Also, electronic self-certification is not sufficient documentation of the nature of a participant’s hardship. IRS audits show that some TPAs allow participants to electronically self-certify that they satisfy the criteria to receive a hardship distribution. Self-certification is enough to show that a distribution was the sole way to alleviate a hardship, but self-certification cannot be used to show the nature of a hardship. A plan sponsor must request and retain additional documentation to show the nature of the hardship.
The IRS advises that a plan sponsor retain the following records, in paper or electronic format, for each plan loan granted to a participant:
1. evidence of the loan application, review and approval process;
2. an executed plan loan note;
3. if applicable, documentation verifying that the loan proceeds were used to purchase or construct a primary residence;
4. evidence of loan repayments; and
5. evidence of collection activities associated with loans in default and the related Forms 1099-R, if applicable.
If a participant requests a loan with a repayment period of more than five years in order to buy or build a primary residence, the plan sponsor must obtain documentation of the home purchase before the loan is approved.
If a plan sponsor fails to have records of hardship distributions available for IRS examination, the plan could lose its qualified status and could have to resort to the Employee Plans Compliance Resolution System to correct the error.
With regard to plan loans for buying or building a primary residence, the IRS says that audits have found that some plan administrators impermissibly allowed participants to self-certify their eligibility for the loans.