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hardship grossed up for taxes


AlbanyConsultant

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If the participant isn't electing to withhold anything now (understanding that withholding isn't mandatory on a hardship), can the amount taken still be grossed up to include an amount to cover taxes to be paid later?  I see discussions here on how to actually figure out how much is an appropriate amount to gross up - we're going with a simple 20% of the amount requested, for better or worse.    But I don't see anything that says that if you're not electing to have the taxes withheld now, that takes away the ability to have the distribution increased for the taxes that will be due, so long as you're still under the amount that you have available under the terms of the plan.  Right?  Thanks.

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The Treasury department’s rule provides: “A distribution is treated as necessary to satisfy an immediate and heavy financial need of an employee only to the extent the amount of the distribution is not in excess of the amount required to satisfy the financial need (including any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution).”

26 C.F.R. § 1.401(k)-1(d)(3)(iii)(A) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR6f8c3724b50e44d/section-1.401(k)-1#p-1.401(k)-1(d)(3)(iii)(A).

Consider that how much tax is “reasonably anticipated” leaves room for defending plausible assumptions.

For example, if one uses the middle of the seven marginal Federal income tax rates (24%) and the middle of the nine New York State income tax rates (6.25%), that results in a combined marginal income tax rate of 30.25%. If one assumes many hardship distributions might attract the extra 10% Federal income tax on a too-early distribution, that’s 40.25%. For New York City employees, one might assume (even looking to a middle range) almost 44%.

If one assumes the marginal income taxes are 40.25%, to meet a $10,000 hardship need calls for a $16,736.40 distribution.

A New York City employer I worked with had data to prove its employees’ marginal income tax rates averaged (some years ago) greater than 50%. Yet, the plan’s administrator restricted the gross-up to no more than double the hardship need.

If not already done, consider redesigning the claim form so the claimant specifies the deemed hardship need amount and her desired gross-up amount; and self-certifies that the sum is “not in excess of the amount required to satisfy [the] financial need[.]” I.R.C. § 401(k)(14)(C)(ii).

With this, a plan’s administrator might limit a hardship distribution to what results from using the lesser of the claimant’s requested gross-up or an outer limit estimated on marginal income tax rates, perhaps recognizing that an employer does not know each individual’s circumstances.

If such an outer limit is set for a reasonable range, the amount of such a gross-up alone, without other facts, should not set up that the employer/administrator had “actual knowledge” that the gross-up was more than what 26 C.F.R. § 1.401(k)-1(d)(3)(iii)(A) allows.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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There is a calculator that shows up on various websites such as:

https://www.annuityexpertadvice.com/calculator/401k-withdrawal-calculator/#taxes-on-401k-withdrawal-calculator

https://www.mortgagecalculator.org/calcs/early-retirement-withdrawal.php

You could ask the participant to use a calculator and then provide the number a copy of the report supporting the amount of withholding they wish to have added onto the hardship amount.  This would be a balanced approach between a one-size-fits-all calculation and a more realistic tax estimate that does not have the employee coming back later for a request for a withdrawal to cover the taxes.

If nothing else, the calculators are fun to play with.

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"If the participant isn't electing to withhold anything now (understanding that withholding isn't mandatory on a hardship), can the amount taken still be grossed up (BY WHOM?  THE PLAN ADMINISTRATOR?  ARE YOU TRYING TO SAVE THE PARTICIPANT FROM HIS OWN FOLLY? ARE YOU PLANNING TO BUMP UP THE AMOUNT OF HIS WITHDRAWAL AND SEND 20% AS WITHHOLDING TO THE IRS?  WITHOUT TELLING HIM? IN VIOLATION OF HIS ELECTION NOT TO GROSS UP THE DISTRIBUTION?) to include an amount to cover taxes to be paid later? I see discussions here on how to actually figure out how much is an appropriate amount to gross up -- we're (WHO IS "WE"? DO YOU MEAN "YOU"?) going with a simple 20% of the amount requested, for better or worse. But I don't see anything that says that if you're not electing to have the taxes withheld now, that takes away the ability to have the distribution increased for the taxes that will be due, so long as you're still under the amount that you have available under the terms of the plan." (THE AMOUNT OF THE WITHDRAWAL IS TAXABLE INCOME TO THE PARTICIPANT AND IT WILL BE PAYABLE TO THE IRS [LET'S NOT FORGET THE STATE.] WHETHER OR NOT ALL OR PART OF THE TAX WAS WITHHELD.  I DON'T UNDERSTAND THE QUESTION?)

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22 hours ago, fmsinc said:

But I don't see anything that says that if you're not electing to have the taxes withheld now, that takes away the ability to have the distribution increased for the taxes that will be due, so long as you're still under the amount that you have available under the terms of the plan.

That is correct - any tax withholding election or lack thereof matters not, the permissible gross up is for (anticipated) taxes NOT tax withholding.

Kenneth M. Prell, CEBS, ERPA

Vice President, BPAS Actuarial & Pension Services

kprell@bpas.com

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This is a discussion to have with the participant as they will need to complete the W-4R form prior to their distribution.  The W-4R form could also help them to determine how much they may want to have the distribution grossed up, or at least give them a realistic picture of their potential taxes.

Pamela L. (Bobersky) Shoup CEBS, RPA, QKA

AMI Benefit Plan Administrators, Inc.

100 Terra Bella Drive

Youngstown, Ohio 44505

800-451-2865

www.amibenefit.com

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For some plans, a discussion might be text on or accompanying the claim form to guide the claimant about how much gross-up to request, and about what withholding instruction to give.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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