401(k) Hardship Withdrawals

[Guest 401kgreen]

What's the worst that can happen (in terms of penalties or other legal ramifications) that could result from the plan administrator approving/processing an un-qualified hardship withdrawal? Our TPA told me it could put our plan in default, but what does that MEAN in layman's terms?

[QDROphile]

Plan disqualification means that the employer loses deductions for contributions, no one gets tax deferrral on contributions after the disqualification and highly compensated employees include their entire accounts in taxable income. You may have other complications, including determining the year of taxability. All very bad things that you do not wish to happen.

As a practical matter, the IRS won't disqualify the plan unless you spit on them, but they will use the disqualification to compute what it will cost you as a penalty to get out of the mess.

[RCK]

I'm not sure about the "in default" terminology, but QDROphile is right on point about all the awful things that can happen, but are not likely to.

The standard response in any situation is what does the plan say? Most plans tend to go by the IRS' safe harbor rules for determining what constitutes a hardship withdrawal, but there is no requirement that you do so. So if you are following the plan's rules and they are different from the IRS' rules, then your problem is probably not major. But if the hardship was processed clearly in violation of the plan document, then you do have some degree of problem.

IF the TPA made the distribution, then that is good news from two perspectives--they have a liability, and the IRS is going to look more favorably on the situation. If the sponsor made the distribution, what's the TPA doing?

[Guest BAR]

RCK, To suggest that the TPA isn't doing it's job because a plan sponsor is handling plan distributions smells of ignorance. "Traditional" TPA firms provide different levels of service which are usually based on what the plan sponsor is willing to pay for.

As far as hardships go, wasn't there a well known company about 5-7 years ago that the IRS made an example out of and fined in excess of $1,000,000.00 because they did not limit approving hardships based on the criteria set forth in the plan document. I think it is important that plan sponsors understand there is a really risk here and the TPA isn't going to have a "miracle" solution if they get audited.

[Guest 401kgreen]

Thank you all very much for your explanations!

[RCK]

I apologize for trying to supply a quick answer for 401kgreen's original question. The relative responsibility for this error does of course depend on the agreement between the TPA and the sponsor. In my experience, the majority of small plan (which I assumed this was) administration is done by the TPA.