In Service vs Hardship

[52626]

Company A's has a safe harbor 401(k) profit sharing plan

The plan allows for distribution of account upon the attainment of age 59 1/2 and the safe harbor hardship from all sources of money.

Participant age 60 applies for a hardship for medical expenses not covered by insurance.

I am told by the TPA that since the plan has an In Service Distribution and Hardship, the participant must first take the distribution as an In Service ( subject to the 20% withholding).

I have never heard of this.

Thoughts????

[401king]

From our documents:

A distribution shall be considered as necessary to satisfy an immediate and heavy financial need of the Participant only if:

(g) The Participant has obtained all distributions, other than Hardship distributions, and all nontaxable loans under all plans maintained by

the Employer;

Participants must exhaust all possible methods of obtaining funds prior to a Hardship. I am inclined to agree with the TPA.

[My 2 cents]

Offering more questions than answers:

Is the participant able to take a non-taxable loan (aren't they all, until there is a default on the repayment schedule?)? That would appear to take precedence over either in-service withdrawals or hardship distributions.

The idea that a 60 year old participant has to spend funds earmarked for retirement on medical expenses not covered by insurance makes me sad. How will they be able to accumulate enough funds to make up the difference at this point?

If the participant is over 59 1/2, whether the amount is taken as in-service or hardship, wouldn't it be taxable the same (ordinary income, no early distribution penalty)? Would there be a 20% withholding on a hardship withdrawal? Without a 20% withholding, how would the participant be able to afford the taxes on the distribution when they come due, presumably next year?

Assuming that the account holds more than is needed to cover the medical expenses, would the in-service withdrawal require that the entire account be distributed? Would the portion not needed for that purpose be eligible for rollover, to minimize the tax impact?

[BG5150]

A few answers for you (in no particular order)

Hardships are not eligible for rollover, therefore withholding is optional, and 10% must be taken absent a contrary election.

Check the plan document to see if a partial in-service withdrawal maybe done. If it must be a full withdrawal, there probably is no provision that it all has to be a rollover or all has to be taken in cash. The participant can take the expenses in cash and roll the rest over.

Over 59 1/2, both distributions are taxed as ordinary income. 20% w/h on in-service and optional (10% standard) on h'ships.

How can someone afford the taxes on a hardship if no w/h is done? It's one thing the participant must take into account before they take the distribution.

Budgeting for medical expenses is an unfortunate necessity for many Americans. Does this person have access to a medical FSA at work? Perhaps they could divert a little income a month to that account. It's like tax-free medical care.

[masteff]

I'm a little confused by the original post since the implication is that a hardship is better than an in-service w/ 20% mandatory w/holding. Perhaps it's because I started out at a company that was moderately paternalistic but I'd rather see the employee be forced to do some withholding.

Is the participant able to take a non-taxable loan (aren't they all, until there is a default on the repayment schedule?)? That would appear to take precedence over either in-service withdrawals or hardship distributions.

The regs only require a loan before a hardship, not before an in-service, unless the plan itself requires it.

[BG5150]

The regs only require a loan before a hardship, not before an in-service, unless the plan itself requires it.

It's somewhere in the financial need test.

Treas. Reg.§1.401(k)-1(d)(3)(iv)(E)(1)

[masteff]

The regs only require a loan before a hardship, not before an in-service, unless the plan itself requires it.

It's somewhere in the financial need test.

Treas. Reg.§1.401(k)-1(d)(3)(iv)(E)(1)

Yes, Treas. Reg.§1.401(k)-1(d)(3) is the rules on hardships. As I stated, the regs require a loan for hardships. The regs do not require a loan for a non-hardship in-service distributions, unless the plan itself requires it. My 2 Cents appeared to suggest a loan might be required in both cases.

[My 2 cents]

I did not mean to suggest what might be required - as noted by several, it could depend on plan language. I did mean to suggest that taking a loan would usually be preferable to any kind of withdrawal, since it would not be necessary to gross the amount up for taxes (or have to deal with covering the taxes some other way).

[BG5150]

From Treas. Reg.§1.401(k)-1(d)(3)(iv)(E)(1)

(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...

[Lou S.]

I'm a little confused by the original post since the implication is that a hardship is better than an in-service w/ 20% mandatory w/holding. Perhaps it's because I started out at a company that was moderately paternalistic but I'd rather see the employee be forced to do some withholding.

Is the participant able to take a non-taxable loan (aren't they all, until there is a default on the repayment schedule?)? That would appear to take precedence over either in-service withdrawals or hardship distributions.

The regs only require a loan before a hardship, not before an in-service, unless the plan itself requires it.

To play devils advocate maybe the employee has very large medical deduction expenses and will be getting tax refund. Why should they have to take 20% more than they need to meet the hardship and permanently lose that 20% as retirement savings?

Granted that's "probably not" the fact pattern but just showing an example where no withholding makes a ton of sense. Though I admit usually it is the other way and the employee who takes a hardship gets hit with the double whammy of being woefully under withheld when they file their taxes.