Hardship Distribution for short sale?

[Lou S.]

Interesting question from a participant and I'm not sure where to look for the answer. The participant is $20,000 underwater on principal residence which they are trying to sell. Does this qualify as hardship to avoid foreclosure? Can the participant take a hardship in this case? The Plan uses the safe-harbor rules on what is allowed as hardship.

I haven't run into this before but with this combination of housing market and economy I have a feeling this might not be the last time I get this question.

[J Simmons]

How imminent is the foreclosure? Has the mortgage company started that process? Has it threatened that it will commence foreclosure proceedings by a specified date if mortgage payments in arrears are not caught up before that date?

[Lou S.]

How imminent is the foreclosure? Has the mortgage company started that process? Has it threatened that it will commence foreclosure proceedings by a specified date if mortgage payments in arrears are not caught up before that date?

I'm not sure it would make a difference. They are selling not trying to stay in the place and they need the cash to cover the difference between the sale proceeds (say $280,000) and the amount due on the mortgage (say $300,000). In this case one could argue that participant might be better off allowing the bank to forclose and take the property, though I'm sure there are many other negative implications to that such as adverse credit reporting and possible bankruptcy proceedings to consider.

Does anyone know of any statutory athourity that would allow for a hardship in this case? I haven't found any yet but was wondering if I missed something.

[J Simmons]

The Plan uses the safe-harbor rules on what is allowed as hardship.

Which, then, of the safe-harbor hardship categories are you thinking this situation might fit into?

[Guest Sieve]

You didn't miss anything. There's no statutory or regulatory authority for such a SH hardship. However, if the plan changes to non-safe harbor hardship distributions, then the plan administrator could independently determine that there is a hardship in this circumstance.

Does the plan allow loans? With safe harbor hardships, loans usually must be taken before a hardship distribution can occur.

[Lou S.]

The Plan uses the safe-harbor rules on what is allowed as hardship.

Which, then, of the safe-harbor hardship categories are you thinking this situation might fit into?

I don't think it fits neatly into any of them. The closest is "avoid forclosure" though I think that is a stretch, hence my original question. I think you could argue it that the funds are needed to cover the loan due to the sale but I don't know if the IRS would accept that logic.

You didn't miss anything. There's no statutory or regulatory authority for such a SH hardship. However, if the plan changes to non-safe harbor hardship distributions, then the plan administrator could independently determine that there is a hardship in this circumstance.

Does the plan allow loans? With safe harbor hardships, loans usually must be taken before a hardship distribution can occur.

Thanks. In the past our proto-type did not allow for the non-safe harbor hardsip, but the EGTRRA doc does so that might be an option if the Plan Sponsor wants to go that route.

On the loans yes I agree but there is an exception if taking the loan would "increase the hardship" which would likely be the case here.

Thanks to both of you for your feedback.

[Guest CinC]

I may be putting words in Sieve's mouth (fingertips?), but I read his question as wondering if you could offer the participant a loan in lieu of the hardship distribution - and if that's not his question, then it's mine. The exception you refer to (that a loan may not increase the hardship) means you do not have to force a participant to take a loan instead of a hardship distribution if the loan would increase the hardship. I'm not aware of anything that says you cannot permit a loan if the participant would qualify for a hardship distribution (which appears doubtful here, anyway). Of course, the participant could be maxed out on loans or the account balance may not support as large a loan as needed, but it might be a viable alternative to get funds to cover the shortfall.

[Lou S.]

CinC, yes the participant can take a loan (we did offer that option). The participant does not want to take a loan, also a loan might not be quite large enough to cover the shortfall since it is limited to 1/2 vested account balance. The fact that if he did take a loan he would have further hardship is what would allow him to not be forced to take a loan if the hardship were permitted under safe harbor rules which it does not appear to be.

Though as I understand it, absent an amendment changing to the non-safe harbor hardship rules, a loan may be his only option.

I hope that made sense.

As an aside what are practitioners doing in EGTRRA restatements if you have gotten that far? Are you using the safe harbor or facts-and-circumstance method?

[PLAN MAN]

CinC, yes the participant can take a loan (we did offer that option). The participant does not want to take a loan, also a loan might not be quite large enough to cover the shortfall since it is limited to 1/2 vested account balance. The fact that if he did take a loan he would have further hardship is what would allow him to not be forced to take a loan if the hardship were permitted under safe harbor rules which it does not appear to be.

How does taking a loan lead to further hardship? I'm not following you.

[Guest Sieve]

Plan Man - You first have to accept that there is a hardship in order for a loan to add to the hardship. But, I don't see how selling an underwater house fits in the SH hardship distribution provisions, so it's a moot point by my way of thinking.

But, I think the argument goes something like this: if you can't come up with $$ for a hardship (say, medical expense), then taking out a loan makes paying the medical expense that much more difficult--thus, no need to borrow before taking the hardship distriobution. I don't buy that argument, frankly, because I don't see it the same as the example in the regs: borrowing to buy a house may make you aboslutely ineligible for the loan, so requiring a person buying a principal residence to first borrow causes the home loan to disappear entirely.

Lou -- Here's a link to a recent discussion of the F&C hardship loan issue:

http://benefitslink.com/boards/index.php?s...amp;hl=hardship

There may be more.

[K2retire]

I suspect that Lou's reference to a hardship in post # 8 means that taking a loan would create a financial difficulty for the participant, not that it would somehow magically meet the safe harbor definition of a hardship.

[Lou S.]

Sieve, thanks for the link, very helpful discussion in that thread and good food for though in the EGTRRA restatements. I also agree that being underwater does not fit the SH rules.

K2r - yes, that is exactly right the additional required loan payment itself may create additional financial burden that the participant can't handle.