Hardship - didn't suspend deferrals

[Guest jvandyke]

A participant took a hardship withdrawal, client just realized they hadn't stopped deducting her deferral contributions. (3 have been submitted)

Do these contributions need to be removed from the participants account?

Will there be any tax liability/penalty for the participant/client?

Any help or guidance is appreciated. Thanks!

[QDROphile]

Amend the plan to remove the provision for suspension.

[Kimberly S]

QDROphile, I don't think you can amend away a government mandated requirement.

[John Feldt ERPA CPC QPA]

They should stop allowing the deferrals now. I don't know if it's in 2007-26 EPCRS as a self correction or not.

Excerpts from the regulations:

§1.401(k)-1 Certain cash or deferred arrangements

(d) Distribution limitation

(3) Rules applicable to hardship distributions

(iv) Distribution necessary to satisfy financial need

(E) Distribution deemed necessary to satisfy immediate and heavy financial need. --A distribution is deemed necessary to satisfy an immediate and heavy financial need of an employee if each of the following requirements are satisfied --

(1) The employee has obtained all other currently available distributions (including distribution of ESOP dividends under section 404(k), but not hardship distributions) and nontaxable (at the time of the loan) loans, under the plan and all other plans maintained by the employer; and

(2)

The employee is prohibited

, under the terms of the plan or an otherwise legally enforceable agreement,

from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least 6 months after receipt of the hardship distribution.

[rocknrolls2]

A client of mine did not suspend contributions as required by the plan's terms. We submitted this to the IRS (given the substantial number of participants, the years involved and the fact that other issues were then before the IRS on a pending filing) and initially proposed to refund the deferrals and earnings and forfeit the match and earnings. The IRS accepted this in its compliance statement. In attempting to implement this, however, we discovered that the vast majority of the affected participants had substantially depleted the contribution types from which we would apply the correction that we could not effectively implement them. We also considered it to be inequitable to implement the corrections against those with sufficient contribution types because it would effectively penalize those participants who were appropriately using the plan as a long-term investment in funding for retirement while those less far-sighted participants who had depleted these funds would get off scott free. Therefore, we made a resubmission to the IRS proposing that we do nothing as to the affected participants since we had recently changed recordkeepers and the new vendor was more diligent than the old. The application sat and then the IRS rejected this approach. Instead, they proposed a prospective suspension, but this requires calculating the sum of the amount that should have initially been suspended with earnings and debiting the prospectively suspended contributions against them.. If the participant terminates employment before the amount is depleted, then the plan administrator has to notify the participant that s/he is not eligible to roll over that amount. There should be no problem with implementing this on a self-correction basis provided you might the requirements for self-correction.

[QDROphile]

Kim Sheek:

Please support your implied statement that the law requires a sx-month suspension. It does not.

Whether or not an amendment is a viable solution depends on timing of the events. Whether or not a six-month suspension is a desirable plan feature is a separate question, usually answered by product and not other considerations.

[Kimberly S]

QDROphile, See J4FKBC's quote of the regulations above.

[J2D2]

My recollection is that mandatory suspension applies only if you are using the deemed or safe harbor hardship provisions and that the regs don't require suspension under the facts & circumstances option.

[masteff]

Please support your implied statement that the law requires a sx-month suspension. It does not.

Whether or not an amendment is a viable solution depends on timing of the events. Whether or not a six-month suspension is a desirable plan feature is a separate question, usually answered by product and not other considerations.

QDRO - As the 6-month suspension is provided by the IRS safe harbor regulations for hardship withdrawals, I presume what you're proposing is that the plan abondon the safe harbor. It's extremely important the plan understand the potential consequences of going outside of safe harbor. It's not something to do lightly.

Kim - that section of the regs is tricky to read... the 6-month suspension is listed under what's "deemed" to meet the rules... meaning if you include that and other listed requirements in your plan, then you'll automatically be deemed to be in compliance.

[QDROphile]

Masteff:

I disagree. Life outside the safe harbor is not very scary. However, you are correct that an amendment would not solve the problem if the appropriate standards outside the safe harbor were not met by the hardship distributions in question.

[masteff]

Looking back to the original post... my thought is given the 6-month suspension is part of the safe harbor and not a mandated suspension, one would need to review the exact language of the plan in question but usually it's broad enough that deferrals can be stopped a couple pay periods after the fact and the 6-month timer started from there.

While the regs and possibly the plan use the word "after receipt of the hardship", plan administrative procedures can be used to show that most changes are effective w/in one or two pay periods. The fact that the case in question has gone three pay periods is not sufficiently different to matter. This is part of why, in my last job, we were consistent in using the "one or two pay periods" phrase, even if it normally happened faster; it's a nice security blanket for when things do take longer.