Dividend Payouts and Hardships

[RCT]

Good Morning!

I have a client that sponsors a 401(k) plan with employer stock as an investment option which pays quarterly dividends. The sponsor has elected to give the participants the option to either receive dividends as a cash payment or to reinvest back into the plan.

It looks like we're counting these dividend payouts as normal distributions so, for any participants with employer stock in a Hardship eligible source who has elected the cash payout option for dividends, we are reducing the amount available for Hardship for each dividend payout the participant receives.

So, my question, is this correct? It seems to me that, since dividends are classified as earnings if they are reinvested, payouts should be considered a distribution of earnings and not principal and shouldn't have an effect on the Hardship calculation.

I've not been able to find anything that addresses this specifically, so any thoughts on the matter are appreciated.

Thanks!

[My 2 cents]

My question would be whether dividends on employer stock owned by a 401(k) plan (or on any other stock for that matter) is permitted to be paid out in cash in lieu of reinvestment.  Does the client have any legal advice saying they could do things this way?  It seems to me that the dividends should automatically be put into the 401(k) accounts, to be distributed at such time and in such a manner as called for by the plan's distribution rules.

[MoJo]

7 minutes ago, My 2 cents said:

My question would be whether dividends on employer stock owned by a 401(k) plan (or on any other stock for that matter) is permitted to be paid out in cash in lieu of reinvestment.  Does the client have any legal advice saying they could do things this way?  It seems to me that the dividends should automatically be put into the 401(k) accounts, to be distributed at such time and in such a manner as called for by the plan's distribution rules.

It's legal (under some conditions) and it's a way for the employer to turn a non-taxable dividend payment into a deductible one (whether or not the participant take the cash or reinvest - just by giving them the choice gives the employer the deduction on dividends paid "through" the plan).

[ESOP Guy]

If this is a KSOP you can have pass through dividend payments happen.  They aren't supposed to be treated as regular distributions.  There are rules on how they are supposed to happen and there is even a special 1099-R code for these payments- it is a "U". 

I don't know if I have ever seen a specific answer to the hardship question either.

Sorry, we aren't exactly helping the OP much.  My guess is this isn't a fact set any of the rule makes thought of so there is no solid guidance. When that happens we often invoke the plan provision that give the Plan Administrator the ability to interpret the plan document in a reasonable manner that is non-discriminatory.  The fact they have been doing it the way they have been doing it might have set precedent unless you can make the case it is wrong.   The fact they aren't regular distributions is the strongest fact pointing to the old method is wrong. 

Whichever way you go I would get it determined, documented and done consistently going forward.  In the end the plan's ERISA attorney (maybe that is you) might have to opine on this. 

[RCT]

Thanks for the input - definitely not an attorney, just a point of contact for the recordkeeper and trying to make sense of it. This has been the process for as long as they've been a client - going on 7 years, now - but I'm not sure that it was ever discussed, it's just the way it was done.

Not a definitive yes or no, but I can't tell you the last time I had a question that was that simple in this business! This gives me some validation and a direction to go which is still very helpful. Thanks, again!

[CuseFan]

The dividends are earnings and should not be part of hardship availability, they should be tracked in their own money type and also fully vested.

[ESOP Guy]

2 hours ago, CuseFan said:

, they should be tracked in their own money type and also fully vested.

Like so much of this stuff it can be more nuanced.  That statement is true as long as the people who aren't fully vested are given the ability to take the dividend and the employer is deducting the dividend.  

I work with several ESOPs that only offer the ability to elect to take the dividend to the fully vested employees.  The non-vested employees simply have no choice the dividends stay in the plan.  The employer can only take a deduction for the dividends paid to the full vested employees. 

[CuseFan]

agreed and thanks for the clarification