hardship withdrawals

[Guest zimmer]

The "safe harbor" criteria for hardship withdrawals from 401(k) plans appear to require taking a loan from the 401(k) plan before a hardship withdrawal can be taken. I thought I had read that IRS had changed this rule, but can't seem to find any guidance. Any thoughts?

[Guest Destruo]

I don't recall that the requirement to take all loans prior to a hardship has been eliminated. However, final 401(k) regulation (1.404(k)-1(d)(2)(iii)(B) states that "a need cannot reasonably be relieved by one of the actions listed above (e.g. a loan), if the effect wuold be to increase the amount of hte need." Therefore, if the having to take a Plan loan would create a larger hardship, the participant is deemed to have satisfied this requirement. Oscar

[Tom Poje]

I don't recall reading anything like that.

The regs are clear that you have to take a loan first, then hardship, if plan allows both.

The 'workaround' is to deny the loan - since the ee wants to take a hardship, then the ee is a bad risk, and the plan has a 'right' to deny the loan since it can't expect payment back. Well, that's what I've heard some people do.

[Guest rsmelson]

Note that the IRS takes the position that this loan first rule applies to all plans maintained by the employer, both qualified and nonqualified (before the 401(k) hardship distribution can be made).

[Guest Kmhamilton]

Zimmer -

I am looking at a document entitled "Tax Management Memorandum" published by BNA. In a column entitled "Washington Items - The Climate of Current Thinking on New Developments" the authors describe INFORMAL discussions with tax practitioners.

One item is the issue you bring up regarding hardship withdrawals. This document states the IRS has now taken the position that if a loan is permissable, but the available loan proceeds do not satisfy the amount of the hardship, the hardship may be granted without requiring the loan.

I recall reading this elsewhere, but I seem to recall that it was in a letter from the Service to a consulting firm rather than in a letter to an employer. As this is a recollection, I would operate under the safe harbors until such a notion is formalized into a Revenue procedure, or other such written document.

We still require a participant to take a loan first, then satisfy the additional need through a hardship withdrawal.

[LCARUSI]

Questions to those of you who require a loan before a hardship withdrawal:

What if the participant will be unable to make the required loan repayments?

And if the participant has a substantial account balance, will you require that he or she take a loan which might result in repayment amounts that are huge relative to his or her take home pay?

[Guest Kerry]

We restrict the reasons for a loan to the same ones as a hardship withdrawl. Hope this helps.

[Guest Kmhamilton]

We have just undergone an IRS audit, and the auditors asked specifically for proof that loans were taken prior to harships. The audit was for the 1992-1993 plan years. This reasoning (hardships without requiring a loan) is very recent.

Our experience with the audit also showed that the auditing agent has a VERY LARGE stick without referring to the district office.

Based on the audit requests, and the fact that plans are not necessarily required to offer hardships or loans, we will maintain our current policy until something is passed in writing specifically allowing hardships before loans.

The logic is there that forcing a loan in the face of a hardship causes a greater hardship, but the IRS is not necessarily logical.

In our experience, better safe than disqualified.

[Guest Kmhamilton]

Another hardship withdrawal question:

I have read about the IRS Restructuring and Reform Act's influence on limiting the rollover of a hardship withdrawal effective 1/1/99. (Currently, hardships are eligible rollover distributions - logic of the Service??) As a function of this limitation, the mandatory 20% withholding will be eliminated if the Participant elects out of the withholding.

This was done as a result of a Participant's ability to roll over a hardship withdrawal to an IRA, then to a Roth IRA, then take a distribution from the Roth IRA and avoid the 10% penalty.

Has anyone else heard this or seen actual verification? I have not been able to find it in the Act.

[Guest zimmer]

Thanks, kmhamilton. I knew I had read it somewhere about the loan not being necessary in all circumstances. However, since it's informal guidance only, I agree it's better to stay with the safe harbor guidelines.

[Guest zimmer]

km hamilton -

Section 6005©(2)(A) of the 1998 Act amended the definition of "eligible rollover distribution" in Section 402©(4) to specifically exclude hardship distributions. The new exclusion is found in Section 402 ©(4)© of the Code.

[Guest pdall]

RE: loan before hardship

We have been advised by a pension attorney that as long as you have sufficient documentation, verification from participant that he can not or will not pay back the loan, then you have reason to deny the loan. (no bank will grant a loan if the person tells you outright he will not pay back the loan).