Hardship "grossing up" questions

[AlbanyConsultant]

We have a participant who needs a hardship of $400 to pay back rent due. She only has deferral money in the plan; her hardship available is $472, and her total account balance is $550.

She has chosen to "gross up" the hardship by 20% for estimated taxes, meaning that the actual distribution is now $500. Is this a problem now that the gross distribution will exceed her allowable amount?

Additionally, the product platform takes a $75 fee from the distribution, so we have been doing another gross up of $75 on top of the hardship amount + estimated taxes to cover that for the participants. That put her at $575 total... which is more than she has, so she's going to end up short. I'm OK with that result, but should we not be doing that gross up for the fee?

Thanks for your input...

[BG5150]

She cannot get more than $472 for the hardship, because that's all she has available per the rules.

You apply your $75 fee before or after the distribution, it won't matter, as that should NOT be part of the distribution (IMO). So, after the dust settles, she will have a $3 balance.

(BTW: a 20% gross-up of $400 is $480, not $500.)

[GMK]

(BTW: a 20% gross-up of $400 is $480, not $500.)

Agreed that 20% of $400 is $80, but if she needs $400 and 20% of the distribution amount is withheld for taxes, then she needs a distribution of $500. That is, 20% of the distribution ($500) is $100, which leaves her with $400. No?

And this means that she doesn't have enough to cover the $75 fee, which as you say should be applied before or after the distribution.

[BG5150]

(BTW: a 20% gross-up of $400 is $480, not $500.)

And this means that she doesn't have enough to cover the $75 fee, which as you say should be applied before or after the distribution.

That's what I get for doing math before my morning coffee

My poor math not-withstanding, she can only get $472, fee or not.

[AlbanyConsultant]

Forget the fee for a moment - is she really getting more than $472 for the hardship if we gross up for taxes? In theory that could be withheld upfront, so if she takes $500 then she would get $400. Or does the max including the grossing have to come in under the max available, limiting what she gets as a net check?

The fee is sort of in the wash - the platform takes it from the distribution, so we add it to the transaction so the net amount is still what the participant wants. It's not counted as a "distribution" in their reporting, so I think we're OK with it putting the total above the max available.

[GMK]

As BG said, she can only get $472 (not counting the fee). If she has 20% ($94.40) withheld, the payment to her is $377.60, which is $22.40 short of the $400 she wants. Can she reduce the withholding to 15%?

[ESOP Guy]

Why are you withholding 20%? A hardship can't be rolled over to an IRA so I thought they are subject to 10% withholding per IRC §3405(b)(1).

Been a while since I worked on 401(k)s so willing to be told I am wrong but I am thinking 20% is not required here.

So I think this person could elect 15%.

[GMK]

Good point. I read the OP to mean that she elected 20% withholding (for whatever reason), not that it was required, and that the question was about whether the gross up for taxes was an "extra" that could be distributed in addition to the $472 hardship limit or whether the gross up was part of the total distribution amount that could not exceed $472.

[BG5150]

As far as I remember, the amount of the need can be increased for taxes, but not the funds available.

10% is the standard withholding. However, the participant may elect not to have withholding. Also, they can request more withholding. Nothing that I can see allows less than 10% but more than zero. For example, they cannot request 5% withholding.

[Peter Gulia]

The Treasury department's rule states: "[T]he amount required to satisfy the financial need may include any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution."

Do BenefitsLink mavens read this as allowing a gross-up reflecting the distributee's marginal income tax rates, even if the withholding will be much less?

If so, what information about the distributee does one use to discern what marginal tax rate to assume for the gross-up?

If one assumes that, beyond the distributee's wages from the one employer, the distributee's tax returns might include other wages and other income, could this make it reasonable to accept a claimant's written representation about his or her marginal tax rate (as long as it's no more than the combination of the highest rates for the jurisdictions shown by the claimant's address)?

[ESOP Guy]

The Treasury department's rule states: "[T]he amount required to satisfy the financial need may include any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution."

Do BenefitsLink mavens read this as allowing a gross-up reflecting the distributee's marginal income tax rates, even if the withholding will be much less?

If so, what information about the distributee does one use to discern what marginal tax rate to assume for the gross-up?

If one assumes that, beyond the distributee's wages from the one employer, the distributee's tax returns might include other wages and other income, could this make it reasonable to accept a claimant's written representation about his or her marginal tax rate (as long as it's no more than the combination of the highest rates for the jurisdictions shown by the claimant's address)?

Haven't we had this conversation before?

http://benefitslink.com/boards/index.php/topic/49354-withholding-on-hardship-distributions/

[Peter Gulia]

Wow! Thank you! I had forgotten that earlier discussion.

But what if the plan's administrator does NOT tie the gross-up to anything about withholding?

Is it okay to accept the claimant's written representation about his or her combined marginal tax rate (as long as it's within a range that could be possible)?

[GMK]

If we offered hardships (a comment showing a personal bias against them), I see no reason not to accept the claimant's reasonable claim about their tax rate. We certainly wouldn't ask for prior tax returns, etc., mainly because past records are not proof of current conditions. If you're concerned that participants might take too much of their own money out of their own retirement fund, then why are you offering hardship distributions?

Maybe someone would try to game the system , but most hardship cases are going to be pretty straight forward. It's unlikely that we would hear: "Yeah, I have this "hardship" and need $800. Oh, by the way, since I'm in the 39.6% bracket (and don't have any other source of the $800), bump it up to $1,116.80 ... and maybe I should add another $50 for state income tax."

[Peter Gulia]

GMK, thank you for the further information, and your observations.

It's talk from IRS employees in recent years that has caused some employer/administrators to ask about what one may accept on the claimant's word, and what calls for an administrator to probe and evaluate.