Using other financial resources before taking a hardship withdrawal

[Guest Bud]

In order for a participant to be eligible for hardship withdrawal, the financial need must be one that cannot be satisfied from other resources. Typically, that means taking out loans, exercising stock options, etc.

Does anyone have a plan or know of a plan that requires participants (by its plan terms or hardship procedures) to: (1) withdraw from the company's employer stock purchase plan and use refunded contributions; and (2) use personal credit cards and show that there is no available credit to satisfy the financial need.

Does anyone think plans should require withdrawals from ESPPs and maximum use of personal credit cards?

[MGB]

Personally, no.

[2muchstress]

Most plans I see will say something like (paraphrased) :

The Plan Sponsor may rely on the employee's written representation that the need cannot be satisfied through other means.

In your scenario, if the employee has no credit cards, is the plan sponsor going to make him apply for a credit card and be denied before issuing the hardship? How many times would an employee have to be denied credit before the plan would permit the hardship? There are credit cards available to people with the worst credit, they just also get the worst terms.

Though I am only commenting on part of your question, I think it seems very extreme. I would never request an employee max out a credit card before granting a hardship.

[Brian Gallagher]

as for the loan: if the loan itself would be a hardship, the participant does not have to take that either.

as for the esop: got me.

[maverick]

I agree with 2much, re: relying on a participant's representation that a hardship exists.

A "problem" I see with hardship rules is the requirement that a participant first take a plan loan in an effort to reduce or eliminate the hardship. If the person needs a hardship dist, do you really think he or she can afford loan payments?

If I was king for a day, I'd eliminate loan provisions from qualified plans. Dream on. Recently I saw a plan with 31 people deferring, AND 17 of those 31 had outstanding plan loans!!!!

Maverick

[Brian Gallagher]

not to get off the suject maverick, but i don't see that loan provision going away either. just because the govn't loves them. the money get double taxed! (after-tax payments and taxed when it comes out at retirement)

sorry for the digression, folks.

[2muchstress]

It's actually on the interest portion of the loan payments that is double taxed, which is a pretty small amount anyways. The principle is not double taxed because the money was pre-tax when it was contributed, the loan was not taxed when it was taken, so the principle payment is just replacing the pre-taxed money that was borrowed. It's only the interest on loans that is double-taxed.

[Brian Gallagher]

the money was not originally taxed going in, but when it gets replaced it is taxed when it comes out of the paycheck.

ex:

put in $2000.00 to 401k (pre-tax)

take $1000.00 loan (not taxed)

loan is 5.75% interest.

assume its for 1 quarterly pmt--total will be $1014.38

partic has $1014.38 taken from paycheck for loan payment (taxed once)

acct is now $2014.38

partic takes total distrib. entire 2014.38 is taxed again

[2muchstress]

However, had the participant not taken the loan, he would have $2000 in his account. When that money is distributed, then the $2000 is taxed.

The money he used for the loan payment would have been taxed just the same as if he used it to pay his utilities. So there is no difference. The IRS is getting the same amount in taxes, except they are getting extra taxes on the interest portion when a loan is taken.

[MGB]

There is no double taxation on the principle in this example. They have the 1000 loan in cash and the 2014.38 distribution in cash. They have been taxed on 1014.38 and 2014.38. The only extra taxation is on the loan interest (14.38), as previously stated.

[2muchstress]

Thanks MGB. It feels so good to be right (though it might not happen often).

[Kirk Maldonado]

Because others are digressing, I feel OK about divulging the fact that I had a client one time with about 500 participants with over 150 loans in default. (That's got to be some kind of record!)

(That happened before I began representing them. Needless to say, I told them that they needed to clean up their act before they get audited.)