impermissable hardship distribution

[R. Butler]

Plan granted a hardship distribuion for payment of post secondary education expenses. Plan sponsor did collect a Hardship Statement signed by the participant stating the prupose of the withdrawal, but did not ask for evidence of the requested expense. The employee did not in fact end up attending school. The plan sponsor did have procedures in place requiring that some type of written evidence be collected, but in this case those procedures were not followed. They have had 6 or 7 previous hardship requests and in each case collected written evidence.

A few questions:

1. Can plan sponsor use SCP since procedures were in place, but just not followed in this isolated instance?

2. The general correction is to request that the participant repay the money with lost earnings. In this case the participant has terminated employment. He is not going to cooperate with any correction. What would be an acceptable correction? The concern with an employer corrective contribution is that the participant walks away with that corrective contribution. The plan only contains employee deferrals and safe harbor match and the participant was under 59 1/2, so I don't see that plan amendment is not an option.

Thanks in advance for any guidance.

[Tom Poje]

http://www.irs.gov/pub/irs-tege/401k_mistakes.pdf#page=2

clicking on the link for Q 10 (though in your particular case it sounds like maybe SCP is still available, but this is the IRS reasoning)

Example 3:

Employer M maintains a 401(k) plan with 7,500 participants. Plan provisions allow for hardship distributions to participants. During a review of its operations, Employer M determined that 10 hardship distributions made during the 2007 plan year did not have proper documentation. Further investigation by M revealed it did not base five of the distributions on any hardship, but were nothing more than in-service distributions. There were no written procedures in place to review a participant’s application for a hardship distribution.

Correction Program(s) Available:

SCP:

This mistake may not be eligible to correct under SCP since there were not adequate practices and procedures in place with regard to hardship distributions.

VCP:

Employer M may correct this mistake under VCP. M must request that the five participants who received distributions that did not meet the hardship requirements of the plan repay the amounts plus earnings to the plan. In addition, M must improve the plan’s administrative procedures regarding hardships. Expecting participants to repay these amounts to the plan in full may be problematic because the participants may have already spent the funds. A plan document requiring spousal consents for distributions, plus possible tax issues on the distributions could further complicate the final correction. Correction will depend on all the facts and circumstances of each individual situation and may include, in some form, paybacks, employer corrective contributions and even some form of plan amendment. If this represents your situation, file a VCP application and work with the Voluntary Correction agent to determine the proper correction.

so lets see, if the hardship was $5000, and the person paid it back and then took a distribution because they are terminated, what is the net effect? Maybe the iRS wants their taxes on the lost interest. The person should have already paid taxes on it, so I suppose the possible tax consequences are the person paid taxes in the wrong year ?(if the hardship was from last year)