By Dean Huber
In February the IRS issued a memorandum to its employees involved in the audits of qualified retirement plans. This memo addressed substantiation guidelines for hardship withdrawals that are treated as “safe harbor” withdrawals under Treasury Regulations. Specifically, the guidelines outline the process for determining whether a hardship withdrawal was made “on account of a deemed immediate and heavy financial need” which is a requirement for a safe harbor hardship withdrawal under the regulations. This memorandum follows an article published by the IRS in April of 2015 where they take the position that the plan sponsor’s failure to maintain documentation of the nature of a participant’s hardship was grounds for potential disqualification of the plan. The article specifically states that it was not sufficient to rely on plan participants to keep copies of the documents that proved a hardship withdrawal was on account of a deemed immediate and heavy financial need. These documents generally include items such as the explanation of benefits for medical expenses, the purchase agreement for a primary residence, or the invoice for funeral expenses.
Contradicting the 2015 article, the new memorandum seems to provide a mechanism for using certification and document retention by participants. The memo indicates a plan can be treated as meeting the hardship substantiation requirements without obtaining and retaining the source documents if the following requirements are met:
- The participant must receive a notice about certain hardship rules and agree to retain and make available upon request the source documents.
- The third party administrator must obtain from the participant a summary of information contained in the source documents. This summary of information must include the total cost of the hardship, the amount requested and certification by the participant that the information provided is true and accurate. Additional information that must be included in the summary is detailed in an attachment to the memo and varies based on the type of hardship withdrawal. The summary must generally include details about how costs were incurred, who incurred them and who will be paid.
- The third party administrator must have a process by which it annually provides or gives the employer access to data on hardship withdrawals.
- The plan must have a procedure in place whereby participants don’t receive more than two hardship withdrawals per year. More than two per year are acceptable if there is an adequate explanation.
The memorandum indicates the IRS examiner would audit the summary of information rather than the source documents and request source documents only if the information contained in the summary is inconsistent. If a plan is not using the summary of information approach, or if one of the four requirements above is not met, the IRS examiner will audit source documents to determine whether a hardship was made “on account of a deemed immediate and heavy financial need.”
While information the IRS provides to their examiners does not represent official guidance or law, it does give us insight into the IRS position with respect to various statutes and regulations. Plan Sponsors would be wise to insure that their hardship withdrawal policies are in line with IRS expectations.
At Kernutt Stokes we have a group of employees specializing in employee plans and their compliance with various Treasury and Department of Labor regulations. If you have any concerns about your plans and their compliance with various rules and regulations, feel free to call Dean Huber or Andrea Smith in our office.