If a participant in a salary reduction-only 403(b) plan takes a hardsh

[Guest Parker]

If a participant in a salary reduction-only 403(B) plan takes a hardship withdrawal, is the participant then prohibited from making any salary deferrals to his/her 403(B) account for at least 12 months after receipt of the distribution?

If so, who is responsible for making sure that salary deferrals are not made for the required time period? The employer? The custodian? The participant? The 403(B) is set up as a Custodial Account, provides that the Participant is responsible for determining whether a financial hardship exists, and is not subject to ERISA.

[Carol V. Calhoun]

Although many employers provide that a participant is responsible for determining whether a hardship exists, I've never been convinced that it is that easy. The problem is that if an individual takes an impermissible hardship withdrawal, his or her whole 403(B) contract is disqualified. See Example 35 of the IRS audit guidelines for 403(B) plans, which states as follows:

EXAMPLE 35: Employee A began participating in a 403(B) plan ("Plan") in 1989. The Plan is funded through both salary reduction and salary reduction contributions, which are invested in annuity contracts. A is 30 years old, has not separated from service and is not disabled. In 1998, A makes a $5,000 withdrawal that is not a hardship withdrawal. If any portion of the withdrawal is attributable to salary reduction contributions and the earnings thereon, the early distribution restrictions of § 403(B)(11) would be violated.

And if the contract is disqualified, it is not just the employee's taxes which are affected. Employer contributions to a nonqualified annuity are treated as wages, subject to employment taxes. And if the employer fails to withhold applicable income and employment taxes, the IRS can hold the employer liable for the amount of the taxes which should have been withheld. So regardless of who is "responsible" for compliance with the hardship withdrawal rules, it is in the employer's interest to make sure that the rules are being followed correctly, rather than merely allowing participant's to certify their own hardships.

And yes, the one-year nonparticipation requirement (which would be lowered to 6 months under the tax bill just passed by Congress) is one way of assuring compliance with the portion of the hardship withdrawal rules requiring that the participant not have other assets available to meet the need. Of course, it is still necessary to show that the participant has a hardship in the first place.

The problem here is that although governmental and church 403(B) plans are exempt from ERISA, other 403(B) plans are exempt only if they follow certain guidelines set forth in Department of Labor regulations, which require minimal employer involvement. Making decisions on hardship withdrawals might be too much employer involvement for this purpose. Thus, an employer which is subject to ERISA may want to limit participant's choice of annuities to ones in which the issuer is willing to take responsibility for administering the hardship withdrawal rules, and indemnifying the employer if impermissible hardship withdrawals are made. So long as there is still a reasonable selection of investments available, this would appear to be within the regulatory guidelines.

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Employee benefits legal resource site

[Guest Bob Tepatti]

What procedures are other 403(B) carriers following when a person makes or requests a hardship withdrawal? Do you:

(1) Notify the administrator/sponsor that a 403(B) participant has requested a hardship withdrawal?

Include the amount or simply the fact that a hardship withdrawal has taken place;

(2) Have policies or thoughts relative to the 403(B) participant's right to privacy compared the the administrator's/sponsor's right to know in order to administer a compliant 403(B) program;

(3) Include language on your 403(B) withdrawal forms, salary reduction agreements, and other similar written documents indicating that a hardship withdrawl may result in suspension of salary reduction contributions for up to 12 months;

(4) If sponsor/administrator notificaiton is not part of your procedures, when a hardship withdrawal takes place, do you notify the annuitant that contriubutions will have to cease for 12 months and suspend contributions, notify the annuitant and take no action relative to the contributions, or take no action at all.

Thank you.

[Guest mike webb]

Question for Carol Calhoun; in the penultimate sentence of your response, did you mean to say "Thus, plans which are not subject to ERISA.." as opposed to "Thus, plans which are subject to ERISA...".? The answer seems to make more logical sense if the latter phrasing was meant.

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Mike W.

[Guest mike webb]

Please amend my last reply to address the phrase in question properly ("Thus, an employer which is subject to ERISA...").

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Mike W.

[Guest Bob Toth]

The individual employee under a non-ERISA plan would be responsible for the tax effects of non-compliance with the hardship rules-and for complying with the rules.

403(b)programs (unlike 401(a)programs)are like IRAs in many ways. But for the non-discrimination and annuity/custodial account rules, they are premised on the individual's own tax liability. The only obligation of the employer in 403(B) non-ERISA plans is to make sure that it has a reasonable basis for its decision to report the elective deferral as being properly made under a 403(B) plan. Thus, if the employer knows (for example) that the 403(B) vendor asks for a representation from the participant that the events qualifying for a safe-harbor (or otherwise) hardship have occured, both the employer and vendor have fulfilled their obligation: it is up to the employee to advise the employer of the need to stop withdrawals.

Remenber, too, that the 12 month suspension is only a condition to meet the "deemed" necessity to satisfy a fiancial need under 1.401(k)-1(d)(3). It is possible for an employee to meet the hardship requirement without a 12 month suspension-something which neither a non-ERISA plan or a vendor have any way of verifying.

Ultimately, it is the individual's obligation, (and his or her tax liability which is affected)-not the employer's, as long as the employer's 403(b)program provides a reasonable basis upon which to report the elective deferrals as tax-deferred.

[Carol V. Calhoun]

Unfortunately, the tax liability is not just that of the individual participant. The employer is liable for the taxes which should be withheld. And if it is unaware that there is a problem, and therefore fails to withhold the correct amount of taxes, the IRS can go after the employer, instead of the employee.

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Employee benefits legal resource site

[Guest Bob Toth]

Carol, I don't totally agree, but I think it is only a matter of magnitude. Keep in mind that the basis for the tax liability on the employer is the withholding obligation. The withholding obligation is premised upon an employer having a reasonable basis for determining whether or not the deferral should be reported as tax-deferred.

The employer cannot hide its head in the sand and do nothing, even in a voluntary only plan. But, unlike a 401(a) plan with the attendant obligations of a plan administrator, the employer's obligations do not run to the specificty of compliance with any particular rule. It runs, instead, to the reasonableness of the process it adopts.

An individual's failure of the hardship rule does not disqualify all of the employees from favorable tax treatment, it only affects that particular employee. Particularly where a withdrawal can be judgmentally based (such as a hardship), where there is no absolute requirement to take a 12 month suspension, it is patently unreasonable to require an employer to levy such a suspension. Indeed, a case could be made that this could cause a non-ERISA employer to be considered an ERISA plan. The employer and vendor have no choice but to rely upon the representations of the employee in such a case, as there really is no other way to comply without doing a full fledged investigation of each hardship claim.

It is important to differentiate between the obligations of an employer under a 401(a) and a 403(B) plan, and hardships represent a classic difference.

[Carol V. Calhoun]

I would agree that regardless of the theory, the IRS is unlikely to go after an employer in instances in which the employer took reasonable efforts to avoid a problem, and the problem occurred anyway without the employer's knowledge. I guess my question is only what happens if the employer is aware that the issuer of a contract will allow hardship withdrawals with no effort at all to identify either whether the purported hardship would be considered a hardship under the regulations (either under the safe harbors, or under the general tests set forth in the regulations), or whether there are other means available to meet that hardship. Can the employer be said to reasonably believe that the amount contributed to such a contract is not subject to withholding?

I am not particularly concerned about a situation in which the contract provides for the specific circumstances which would constitute a hardship, and provides that a hardship withdrawal would be available only if the participant certifies that such a hardship exists, and that there are no other resources to meet the need. What I am more concerned about is a situation (which appears to be quite common) in which the contract merely says that withdrawals will be available in the event of a hardship, makes no effort to define "hardship," and then requires the participant only to certify that s/he has a hardship, without even specifying what the hardship is. Trust me, in the latter situation, the most reasonable belief is that at least some participants will consider it a hardship to have to pay the credit card bill they incurred last month to buy a yacht, and will not take into account at all that they could meet that need by liquidating investments other than the plan account. (I've obviously been practicing WAY too long, and have become quite cynical!)

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Employee benefits legal resource site

[Guest Brent Rowell]

I disagree with the remedy suggested. The employer is not required to deny the salary reduction requests within 12 months ... BUT THE EMPLOYER IS REQUIRED TO WITHOLD

My understanding is that witholding issues are what force the employer into exclusion calculations etc.

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Brent

[Guest TWard]

In a non-ERISA 403(B)(7)plan, the determination with respect to hardship distributions is often left to the custodian since the Employer's involvement could trigger ERISA. When the burden of making determinations regarding hardships fall to the custodian, is it better for the custodian to adopt the Employee Representation guidelines or the Safe Harbor provisions when dealing with hardship withdrawals? Should the custodian require proof that all criteria have been met before granting the distribution request?

[Carol V. Calhoun]

I'd say this one is a judgment call. Obviously, the safest course is to go with the safe harbors, since the safe harbors provide a "cookbook" for making sure that withdrawals are permissible. But it has been my experience that employers (and presumably third-party providers) who try to use the safe harbors often sooner or later get tear-jerker cases which for one reason or another do not meet the safe harbors. At that point, the question is how much of a legal risk to take, versus to what extent the entity responsible for deciding on hardship withdrawals is going to lose business or suffer in a public relations sense (even leaving aside the moral aspects!) if the request is denied.

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Employee benefits legal resource site

[Guest Mary Warren]

I need guidance on where to get specific information which I can understand about my 403(B) annuity policy. Thumbnail scenario: I quit my job at a not-for-profit organization in March 1999. My time has been devoted to caring for my octagenarian parents; my father is a cancer patient, and a recent laryngectomee; my mother is showing early signs of Alzheimers. I took my pension monies out to live on for the 1999 year to make myself available to care for them. I am now facing taking additional time off work to continue care for my parents. No contributions have been made to my 403(B) since May 1999 (I was receiving wages for accrued vacation time until May). Will my policy go into default? Will I be penalized by the IRS for surrendering my annuity policy early (matures in 2025; originated Jan 1 1986) in order to continue to be available to care for my parents? Would this be considered a hardship? My folks live on a very small fixed income, and we are trying to keep them out of nursing homes. I am wondering if the Family Leave Act might have put a different light on the subject of such penalties. I would like to get as much information on the subject, however time is limited as I must decide soon on what to do so bills can get paid! Any help or direction would be appreciated.

[Carol V. Calhoun]

Your annuity contract is required to be fully vested. Thus, failing to pay further premiums will not cause it to lapse, or you to lose what is already in it.

With respect to your questions regarding availability of and penalties for early withdrawal, you've got two different questions here. The first is what the annuity contract itself says. Even if a particular form of distribution (e.g., a hardship distribution, or a distribution upon separation from service) would be legal, a plan is not required to offer it. Similarly, an annuity issuer can impose surrender charges on early withdrawals from an annuity contract, even if the Internal Revenue Code does not. Thus, it is important to read the contract itself to determine what it says.

Second is the restrictions on distributions imposed on 403(B) plans by the Internal Revenue Code. Under those rules, most distributions of salary reduction contributions cannot be made earlier than (i) when the participant attains age 59½, (ii) when the participant separates from service, (iii) when the participant dies, (iv) when the participant becomes totally and permanently disabled, or (v) when the participant faces a hardship. Moreover, only the original contributions, not the earnings thereon, can be distributed in the event of a hardship.

Thus, since you have separated from service, you need not worry about the hardship distribution rules. Rather, the only issue in terms of your ability to get a distribution is whether your plan or annuity contract allows for distributions upon separation from service.

If you have not attained age 55 when the distribution is made, you will be subject to an additional 10% tax on the taxable amount distributed. This additional tax would be in addition to (a) any surrender charges imposed by the annuity issuer, and (B) ordinary income taxes. However, this rule merely imposes an additional tax on a distribution, it does not preclude one.

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Employee benefits legal resource site

[This message has been edited by CVCalhoun (edited 01-26-2000).]

[Guest]

[GBurns]

To CV Calhoun...in your response on 8-12-99 you quoted Example 35 and stated that this action disqualified the participants 403(B) plan. I read the link etc and nowhere do I find such an inferrence in the IRC or Treas Regs. IRC 403(b)11 which is referred to in the example seems to say that there would be a "premature" distribution nothing else. Where did you see disqualification?

[jlf]

Mary Warren, I can help. Call me at 1800-242-1421 press * 2524. jlf

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