401(k) Hardship Withdrawals

[Guest average_guy]

We employ the safe harbor rules regarding 401(k) hardship withdrawals. A participant has requested a withdrawal for the purchase of a primary residence, which is an existing house in need of repairs. In addition to requesting the cash needed at closing, he is also asking for an amount necessary for roof repairs and painting. Under our past procedures we would not approve a withdrawal for household repairs - for a home already owned by the participant. We would, however, approve a withdrawal for building a home - including roofing and painting. And, certainly, if the participant could structure the deal so that the repairs would be paid by the seller and and added to the sales price, then they would be eligible for hardship withdrawal. My question: Are we permitted to treat home repairs (at the time of purchase) as part of the purchase price, making their cost eligible for hardship withdrawal?

[Guest dmj1998]

my two cents :

i think you are right to think that the IRS is more concerned with not finding hardship withdrawals specifically for home repairs if an audit were to be performed. If the buyer and seller agree to have the seller arrange for the repairs and the price of the house is raised accordingly, who could argue that the higher price paid would be the true amount of the transaction? I think the problem the participant will run into is trying to negotiate with the seller to do this (potentially artificailly raising the capital gains for the seller?), especially if the seller finds out the buyer needs a hardship w/d to close the deal. That might be enough incentive for the seller to walk away from the deal altogether.

[Guest average_guy]

Thanks for your reply dmj1998. Since the participant is a HCE, I'll be safe and use my most conservative interpretation - and deny him the harship withdrawal. Of course, since he is a HCE, this also means that he will try to influence the ultimate decision... we'll see what wins out.

[Guest Jennifer Reid]

If I was this HCEs employer, I would have to question his judgment and his worthiness of being an HCE if he needs to withdraw money from his retirement assets to buy a house, much less to buy a house in need of repairs that he can't afford.

[Guest dmj1998]

Jennifer - as a plan sponsor, it is not anyone's decision to determine who should be an HCE other than the IRS, and they only care about how much money you make and not what kind of person you are.

That being said, your comment is very judgemental and uncalled for in this context, especially since neither of us are familiar with the facts of the request. AG's concern is legitimate, but the participant's request to take a hardship is legitimate as well. I can state with much certainty that, depending of the region of the country you live in, purchasing old homes and repairing them for resale is an investment strategy that can pay off better than any investment available in most traditional 401(k)s will ever hope to, and you don't have to retire to get the money. This HCE may be more prudent than all of us combined.