Ineligible Hardship and No Suspension of Deferrals

[KateSmithPA]

A client left us totally out of the loop with a hardship withdrawal taken in April. We have just found out that a participant took a hardship out of profit sharing dollars but the plan states that only deferrals may be used for hardship withdrawals. Also, the client did not suspend deferrals after the hardship.

We believe the participant should reimburse the plan for the amount taken out of profit sharing. Would that be the correct fix to that problem?

We also believe the deferrals that have been deposited after the hardship withdrawal should be returned to the participant, with earnings. Again, is that correct?

Thank you.

[masteff]

1) The assumption is that it was a valid hardship reason and was properly documented.

2) Does the plan allow for in-service w/drwl of PS and if so, would this qualify for the amount taken from the PS source (i.e., could the participant have taken the PS money disregarding the hardship)?

3) Please clarify, did the w/drwl come only from PS or did it come first from deferrals and then from PS? If it came only from PS and the participant has sufficient deferrals, then simply reclassify the withdrawal (ie move identical amount/shares from deferral source to PS source, thus correcting the source the withdrawal came from). If it came from both deferrals and PS, first see #2 above and then, yes, the money needs to go back into the plan.

4) Yes, deferrals should be returned. But only to extent of normal timing. So if it normally takes 1-2 pay periods before deferral changes are applied in payroll, then apply same timing here. Since it's in the same year, if it's possible to run a negative deferral adjustment thru the payroll system for the amount of the deferrals being returned, then I'd suggest that as it puts the employee's taxable wages back to the right amount. Also, check whether the employee received any matching contributions which will need to be taken back.

[KateSmithPA]

1) The assumption is that it was a valid hardship reason and was properly documented.

2) Does the plan allow for in-service w/drwl of PS and if so, would this qualify for the amount taken from the PS source (i.e., could the participant have taken the PS money disregarding the hardship)?

3) Please clarify, did the w/drwl come only from PS or did it come first from deferrals and then from PS? If it came only from PS and the participant has sufficient deferrals, then simply reclassify the withdrawal (ie move identical amount/shares from deferral source to PS source, thus correcting the source the withdrawal came from). If it came from both deferrals and PS, first see #2 above and then, yes, the money needs to go back into the plan.

4) Yes, deferrals should be returned. But only to extent of normal timing. So if it normally takes 1-2 pay periods before deferral changes are applied in payroll, then apply same timing here. Since it's in the same year, if it's possible to run a negative deferral adjustment thru the payroll system for the amount of the deferrals being returned, then I'd suggest that as it puts the employee's taxable wages back to the right amount. Also, check whether the employee received any matching contributions which will need to be taken back.

[KateSmithPA]

Thank you for your response.

I, too, am assuming it was processed properly.

The participant took all he could from deferrals. The balance came from profit sharing.

The plan allows in-service withdrawals but he does not meet the age requirement.

The client consistently deposits deferrals late. The hardship was taken 4/22. His next contribution was deposited 5/25. We are thinking of reclassifying it as psp and fixing the payroll situation outside the plan.

Again, thank you.

[rcline46]

Note that the rule for suspending deferrals for 6 months is a Safe Harbor Hardship W/D rule. If the plan is NOT using the Safe Harbor rules, then deferrals do not have to be suspended.

[masteff]

Note that the rule for suspending deferrals for 6 months is a Safe Harbor Hardship W/D rule. If the plan is NOT using the Safe Harbor rules, then deferrals do not have to be suspended.

Or, on that line of thinking, could not be suspended until after a small lapse in time (such as after the next regular contribution, which occurred on 5/25). Then run the 6-month suspension to conform to the plan.

[Belgarath]

Rcline - I've seen varying interpretations of 1.401(k)-1(d)(3) on this - your interpretation, and the interpretation that there still has to be a suspension period of at least 6 months. But if not using the hardship safe harbor, then the period can be LONGER than 6 months if desired. I'd appreciate any opinions on this, as I'm not certain myself.

[masteff]

But if not using the hardship safe harbor, then the period can be LONGER than 6 months if desired.

Correct, Notice 2001-56 confirms exactly that. And to clarify, it's not the hardship safe harbor (ie the prescribed list of hardship reasons) but rather matching contribution safe harbor plans that had to reduce to 6 months to maintain compliance. (The IRS has too many different meanings to safe harbor, if you ask me.)

[AlbanyConsultant]

I've got a related question: what does it mean that the plan is not following the hardship safe harbor rules? For example, I just had a client (for whom we only do annual administration) tell me that they've not stopped deferrals on hardships since the new HR person took over that area at the client (she didn't know that rule). Are there any real consequences? OK, there's the plan violation of not following the plan document, but what if the document doesn't "force" them to use the safe harbor requirements in the first place?

[Gadgetfreak]

You know I tried searching when I am adding to a thread that has been dormant since 2007 .

Client just informed me that they did NOT stop deferrals for 6 months after a hardship as we instructed. I see someone posted that we should return all ineligible deferrals with earnings. I assume the 1099 would be issued for the year of deferral which is fine but what about the ADP tests?

Also, what 1099 codes should be used?

Finally, does anyone have any direct reference from IRS/DOL that this is the proper correction method?

Thanks.