Hardship - Loans First?

[austin3515]

Here's my opinion. The regs are very clear that:

a) You do not need to take a loan if it would increase your hardship

b) You are allowed to rely on the representations of your employees for this "needs" portion of the test (assuming safe harbor standards are being used).

SO, if the employee represents to you that the loan would increase the hardship, then it should not be required to make the employee take a loan first. Really, the only way we could possibly have "actual knowledge to the contrary" would be to get copies of their financial information, mortgages, credit cards, personal investment accounts, etc.

Am I way off base here?

[Belgarath]

Nope. (Way off base, maybe, but not on this question...)

[BG5150]

This is what the regs say avout taking a loan first:

(D) Employee need not take counterproductive actions. For purposes

of this paragraph (d)(3)(iv), a need cannot reasonably be relieved by

one of the actions described in paragraph (d)(3)(iv)© of this section

if the effect would be to increase the amount of the need. For example,

the need for funds to purchase a principal residence cannot reasonably

be relieved by a plan loan if the loan would disqualify the employee

from obtaining other necessary financing.

1.401(k)-1(d)(3)(iv)(D)

[austin3515]

So I assume you are agreeing with me? (or at least indicating that I'm not way off base?)

Because reading that, I question how a plan administrator could ever have actual knowledge to the contrary of that...

[Kevin C]

Austin,

Are you talking about relying on the employee's representation THAT a loan would increase the hardship?

Or, relying on the employee's representation of HOW the loan would increase the hardship?

In most cases, I have trouble seeing how a loan would increase the current hardship. I see how the future loan payments could help create a future hardship. But, that's not really what the reg is referring to. For example, the participant needs a hardship for $10,000 in medical bills. How is a plan loan going to increase that amount?

[austin3515]

An interesting point, I do see what you mean. BUT, let's say that the net pay was decrease in such a way that additional medical bills could not be paid. Or if it's tuition, and the employee was planning on allocating a portion of each paycheck to the tuition. Again, we have to have actual knowledge to the contrary.

But you made an excellent point, I had not noticed that nuance before.

[Kevin C]

We had a participant inquiring about hardship distributions say that payments on a maximum loan were so high he wouldn't be able to pay his bills. After a discussion of the hardship and loan rules, he requested a $1,000 loan. Most of our plans, including this one, only allow one loan. A week or two after the dust settled on the loan, we got a hardship distribution request. At that point, he already had the maximum one loan allowed.

[BG5150]

In most cases, I have trouble seeing how a loan would increase the current hardship. I see how the future loan payments could help create a future hardship. But, that's not really what the reg is referring to. For example, the participant needs a hardship for $10,000 in medical bills. How is a plan loan going to increase that amount?

This is my take on the regs.

To be honest, though, I've been less than strict on making people take loans before hardships, using the "loan will create a hardship in and of itself" excuse.