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Guest lindamichals

Hardship Proof

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Guest lindamichals

An employer has asked this question. If upon a plan audit, it was determined there was not sufficient proof attached to a hardship request, who is "liable"? The employee or employer? What are the consequences of allowing a hardship without proper proof?

Also, I'm getting this question alot. Participants are requesting hardships to prevent eviction and/or foreclosure, however, no notice to evict or foreclose exists. The participant simply wants to get "caught up" on their bills otherwise they will receive such notice. Would the unpaid bills be sufficient proof?

Thank you.

Linda Michals

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Guest Sieve

Be VERY careful with hardship distributions, because making distributions to someone under age 59-1/2 from elective deferral accounts without meeting the hardship provisions in the Plan is a potential disqualifying act. Require proof--e.g., court-ordered notice of imminent eviction, medical bills, invoices for college tuition, etc. (if you are using safe harbor hardhsip standards)--before making any hardship distribution. I see it as a fiduciary issue (i.e., liability on ERISA administrator).

EPCRS allows for correction if hardship distributions are made when there are no plan provisions allowing such distributions (EPCRS, App. B, 2.07(2)), but that does not eliminate the need to meet the hardship distribution standards in the regs.: "This paragraph [permitting correction by plan amendment] does not apply unless . . . the plan as amended would have satisfied the qualification requirements of § 401(a) (including the requirements applicable to hardship distributions under § 401(k) . . .) had the amendment been adopted when hardship distributions were first made available."

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Larry,

If the plan used the safe harbor definitions of hardship but paid out a hardship in a situation not quite meeting any of those 6 defined categories, would VCP correction include an amendment (retroactive) that relaxed at least that category to the point it picks up the questionable situation?

The reason I ask is a few years back a TPA administering a grandfather, pre-1974 money purchase pension plan with a 401k provisions assumed that in-service hardship distributions were okay--in all 401k plans--and made the distribution. The plan, by its terms, did not.

We VCP'd it, and our correction was to allow after-tax employee contributions (without adjustment for investment earnings) to be the source of in-service hardship distributions in this plan. There's an old Rev Rul that allows for such even in a money purchase pension plan. We cited that as part of our VCP application and submitted a proposed amendment along those lines. The IRS accepted that amendment as the fix in that situation.

Just curious as to your thoughts and comments on whether you might be able to fix a lax hardship situation by amending (retro) to the lesser standard.

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Guest Sieve

John (don't know if I really ought to respond to someone who uses a fancy disclaimer . . . :P ) --

As you described, the IRS--despite the limited situations in which amendments to a plan are permitted under VCP--will often permit a correcting plan amendment which is very narrowly drawn to cover the single whoops (how do you spell that, anyway?). So, I think that they probably would accept a change from safe harbor hardship events to the more general f & c to cover a good-faith bad distribution or 2. I really don't know what else they could do, because I think disqualification is out of the question for that type of error.

If discovered on audit, like in the OP, I guess you'd have to use tear-stained cheeks to covince the agent that you'll do better in future--I think that would work (even, maybe, without the tear-stained cheeks, because there is little alternative for the Service). I just can't see disqualification for a few of these. However, if the audit is expanded and it is determiend that there are a whole slew of lax hardship distributions--i.e., all of them, and there are a lot--such that it rises to the level of bad-faith determinations of hardhsip, then I would expect the IRS to very seriously contemplate disqualifying the plan as failing the exclusive benefit rule (or whatever that over-arching umbrella rule is called).

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An employer has asked this question. If upon a plan audit, it was determined there was not sufficient proof attached to a hardship request, who is "liable"? The employee or employer? What are the consequences of allowing a hardship without proper proof?

Also, I'm getting this question alot. Participants are requesting hardships to prevent eviction and/or foreclosure, however, no notice to evict or foreclose exists. The participant simply wants to get "caught up" on their bills otherwise they will receive such notice. Would the unpaid bills be sufficient proof?

Thank you.

Linda Michals

You might also re-examine what you're considering a "notice to evict/foreclose". They do not have to be in actual eviction/foreclosure, just "imminent" threat of it. Most landlords/lenders will provide a "you're past due, pay up or we may start the process to evict/foreclose" letter, especially if it means they'll get paid all the faster.

See a prior post I made here: http://benefitslink.com/boards/index.php?s...st&p=163431

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Guest Sieve

I don't see where "imminent" threat of foreclosure--if that's even the standard in the regs--is met by the bank threatening to commence a foreclosure action in its standard letter when the employee is a month or 2 late. The reg cited in the referenced link doesn't say you have to be in "immediate" threat of being foreclosed--it says that preventing a foreclosure is automatically an "immediate and heavy" financial need. The word "immediate" does not refer to foreclosure, and immediate and imminent are not the same. If you want to be technical, making a payment on time certainly prevents the possibility of a foreclosure, so under a loosened standard that would be a hardship, too. Hardship distributions are serious business from the IRS perspective.

Don't leave it all up to the employer. The advisor needs to set parameters within which the employer can make a call. Don't let the employer make hardships too easy. You'll have lots of 'splainin' to do when the IRS audits.

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Isn't the language in the safe harbor categories "necessary to prevent" foreclosure?

In my state, the home buyer has 120 days after foreclosure proceedings are formally begun and noticed up in order to prevent foreclosure sale to a third party.

Maybe a 10-day demand letter from an attorney that foreclosure proceedings will be started if the entire past due amounts are not brought current before then would do.

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"necessary to prevent" is the real issue as John notes. The full discussion of that other thread I linked discusses to what extent the risk of eviction/foreclosure must be current (ie imminent) for it to be a valid hardship reason (i.e., excess other bills making it difficult for the participant to pay their mortgage and therefore "maybe" becoming past due is insufficient to "prevent" a foreclosure; the actual threat of foreclosure must be imminent for it to be preventable, IMO).

The reality is how do you apply the regs in the real world as an administrator; remember, the goal is sufficient documentation for the file to prove an eviction or foreclosure was being prevented. We relied upon letters such as those I noted above. We never required that actual eviction/foreclosure proceedings have been actually commenced before allowing the hardship. Remember that the right to evict/foreclose is a standard part of nearly every competent least/mortgage and simple reminder from the creditor of that should be sufficient to put the participant on notice. Not that it proves I'm 100% correct, but we did have full IRS and DOL audits during my time and while they questioned other items on hardships, they never took issue w/ our eviction/foreclosure documentation.

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Guest Sieve

You're absolutely right that process is critical. You're making a judgment call that making a single timely monthly payment doesn't make a harship distribution "necessary to prevent" foreclosure, but if I then get a letter from my bank 15 days later threatening foreclosure then maybe that payment is, in fact, "necessary to prevent". Or if you draw your line only when a notice is received after the 2nd missed payment--or some other time--then that makes it an appropriate hardship distribution. I just happen to draw my line a little more conservatively--and that's fine, since the real issue is that there is a reasonable interpretation of the regs, performance of due diligence, consistency, use of reasonably objective standards, etc. Guidance is a bit sparse, and we do what we can in those circumstances.

But, for my part, rightly or wrongly, I wouldn't accept a letter that says "pay or we can/will commence foreclosure proceedings" any more than I'd accept a letter from a doctor saying "your condition requires surgery which will cost $15,000" when somone claims a medical expense hardship ("Expenses for (or necessary to obtain) medical care . . .").

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I agree with Larry. The letter from the mortgage company needs to be more concrete than may/can foreclose. It needs to specify something like, "if you do not pay $X by Y date, then steps toward foreclosing will be taken." In my view, only when the mortgage company's threats get that 'connected' is the financial hardship 'necessary to prevent' foreclosure. That's where I've drawn the line in the sand.

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and that's fine

We'll agree there are different levels which a plan might require before accepting an eviction/foreclosure hardship. I'm apparently from the less conservative school.

So back to the orginal post...

What are the consequences of allowing a hardship without proper proof?

The plan has a burden to have some form of documentation on file to prove you complied w/ your own plan document which says w/drwls are only allowed for X, Y and Z reasons. The consensus is some form of notice from the creditor regarding either potential or actual eviction/foreclosure proceedings.

The participant simply wants to get "caught up" on their bills otherwise they will receive such notice. Would the unpaid bills be sufficient proof?

The consensus is that no, other unpaid bills that "might" cause the participant to become past due on their rent/mortgage are insufficient. The fact that someone owes $500 on their QVC credit account does not prove they will be subject to eviction/foreclosure on an unrelated lease/mortgage.

My most common saying to participants in this situation is: "The IRS has a much stricter definition of 'hardship' than you and I do. The IRS's definition is very narrow and the plan is limited to only what the IRS and Congress provided as hardship reasons." People have a psychological barrier to letting their mortgage go past due when they'll willingly let multiple credit cards slide w/ exorbitant late fees; people can be counterproductive until you can get them to understand the circumstances in which the plan can help them.

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Guest Sieve

masteff --

Thanks for bringing us back to the OP and your good summary for Linda.

I would just add that the administrator must apply standards that are consistent and that demonstrate a good-faith attempt to meet the requirements of the regs. If the administrator's standards for determining hardship are so lax that appropriate and relevant documentation is totally lacking, then these distributions might well be in violation of plan terms and IRS regs, and, ultimately, could result in plan disqualification. As conservative as I am in my approach to hardship distributions, I concede that disqualification is an extremely limited possibility--but you do need to convince the employer to take those standards seriously.

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Am I hallucinating that there used to be something that said the plan administrator was entitled to rely on a written representation by the employee as to the hardship without requiring any proof unless the employer had actual knowledge to the contrary?

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Not hallucinating. An ER can rely on the EE's representations, if nothing known to the contrary, to establish that there are no other available resources to satisfy the immediate and heavy financial need. Treas Reg § 1.401(k)-1(d)(3)(iv)©.

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Guest Sieve

And, the six safe harbor hardships are "deemed " to be demonstration that there is an immediate and heavy financial need, but the regs don't allow the administrator to rely on the employee's statement that there is such a hardship. (Treas. Reg. Section 1.401(k)-1(d)(3)(iii).) So, some prooof of the existence of the hardship is still required. As John indicates, the reliance on an employee representation which the regs permits goes to whether other means are available to meet that need--not as to whether a hardship exists.

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