401(k) Safe Harbor Hardship Withdrawals

[Guest rocnrols2]

Employer X maintains a qualified 401(k) that permits in-service withdrawals of elective deferrals under the safe-harbor hardship withdrawal rules. During 2003, Participant A makes a hardship withdrawal. Participant A also has exercisable shares under the X nonqualified stock option plan. For purposes of the 6-month suspension, since no contributions are made to the stock option plan, does this mean that A is precluded from exercising his or her options during the 6-month suspension period?

[jaemmons]

IMO, the plan administrator should preclude the employee from exercising the options during the suspension period, if the amount to be exercised is at least the amount of the hardship withdrawal. Because they are using the safe harbor hardship rules, it would be difficult to argue that they met the "immediate and heavy financial need" if they turn around within the suspension period and exercise their nonqualified options at an amount equal to or greater than the hardship withdrawal. I would look at the $'s involved and go from there.

[Guest rocnrols2]

Thanks, jaemmons. Since the regs apply to all stock options and do not limit it to the amount of the hardship withdrawal, I would be hard pressed to justify a rule limiting the suspension to the dollar amount of the withdrawal. In X;s case, employees may make a cashless exercise (i.e., where the employee surrenders the total number of shares equal to the strike price and the applicable federal and state withholding amounts, and receives the net amount of shares). This may make it difficult to apply this rule in a cashless exercise.

The reason I raised this question is that the regs, the preamble and the treatises I have read merely parrot the regs without specifying how they should be applied to nonqualified stock options. In the case of an employee stock purchase plan, suspending deductions to purchase company stock for 6 months makes more sense.