Hardship withdrawal for purchase of primary residence

[alwaysaquestion]

I have a participant wanting a hardship withdrawal to purchase a primary residence.  I have been looking for what is not allowed in the closing cost.  For example can they be reimbursed for the down payment they already made or for the amount going into escrow for property tax and homeowners insurance which would be part of the monthly mortgage payments.  My thought is that these are not "immediate and heavy financial needs"  is there something in writing that I can send other than "immediate and heavy financial needs"

[CuseFan]

Reimbursing for a down payment already made seems contradictory to an immediate and heavy need as the need has already been satisfied by other funds. However, escrow funds - although dispersed later for taxes and/or insurance may not seem like an immediate need - the bank's requirement that such funds be deposited in order to secure the mortgage does indeed create an immediate and, depending on the locality, heavy financial need that I would consider a hardship item.

[hr for me]

Back in the day of our first home, we borrowed $10k from my FIL to make the down payment until the hardship withdrawal could be processed (think quarterly balance forward processing NOT daily mutual funds).  We needed the funds , they just weren't getting to us in time to make the contract/closing happen. But it was still an immediate and heavy need since it was a balloon-payment loan.

 

[TPAJake]

I've processed plenty of hardships prior to closing, never have I reimbursed after closing

[RatherBeGolfing]

The fact that the hardship distribution "reimburses" an expense that has been paid does not necessarily mean that the hardship is no longer there or that the participant should not be able to utilize a plan feature.

For example, I have 2,000 disposable income until my next paycheck, of which I need at least $1,500 to cover expenses.  I end up with a medical emergency and I need to pay the hospital $1,000.  Knowing that my 401(k) plan allows for hardship distributions, I pay the $1,000 from my checking account and apply for the hardship to "reimburse" myself for the expense.  The medical bill has been paid, but without the hardship distribution, I can no longer cover my expenses.  Do I not have a hardship because I used the money in my checking account to pay for the bill?

I asked a similar question a few years back at the ASPPA annual IRS Q&A.  The issue was that most of the hospitals in my area are requiring payment for services before you leave the hospital instead of the old approach of a payment plan.  If you cannot pay your bill, they will set you up with something like MedMax, Care Credit, or some other type of financing.  In the end, the hospital is paid in full, and the patient walks out with an open line of credit that will take you to court and destroy your credit if payments are not made.

Long story short, we started seeing a lot of hardship applications to pay off these medical credit lines.  The question then becomes is it still a hardship if the bill has been paid through other means, in this case a medical credit line or a credit card. 

The answer from the both the ASPPA panel and the IRS was that what triggered the eligibility for a hardship was the medical expense.  Whether the debt was already paid doesn't matter because it is the expense that is the hardship.

So, since costs related to the purchase of a primary residence is an eligible hardship under the safe harbor definition, does it matter that those costs first came out of the participants checking account if those costs could have been paid with the hardship distribution?

It will probably depend on the facts and circumstances, but I would not disqualify a participant just because they are looking to recover a payment they already made. 

[CuseFan]

Great points! And as an aside, looking through the judgments listed weekly in the newspaper (you remember those), the majority are to hospitals or other healthcare providers - attached to people without 401ks from which to take hardship distributions. I guess this just reaffirms the importance of having that safety net available, as well as a statement on our healthcare system - but that's another story for another time.

[K2retire]

13 hours ago, RatherBeGolfing said:

The fact that the hardship distribution "reimburses" an expense that has been paid does not necessarily mean that the hardship is no longer there or that the participant should not be able to utilize a plan feature.

For example, I have 2,000 disposable income until my next paycheck, of which I need at least $1,500 to cover expenses.  I end up with a medical emergency and I need to pay the hospital $1,000.  Knowing that my 401(k) plan allows for hardship distributions, I pay the $1,000 from my checking account and apply for the hardship to "reimburse" myself for the expense.  The medical bill has been paid, but without the hardship distribution, I can no longer cover my expenses.  Do I not have a hardship because I used the money in my checking account to pay for the bill?

I asked a similar question a few years back at the ASPPA annual IRS Q&A.  The issue was that most of the hospitals in my area are requiring payment for services before you leave the hospital instead of the old approach of a payment plan.  If you cannot pay your bill, they will set you up with something like MedMax, Care Credit, or some other type of financing.  In the end, the hospital is paid in full, and the patient walks out with an open line of credit that will take you to court and destroy your credit if payments are not made.

Long story short, we started seeing a lot of hardship applications to pay off these medical credit lines.  The question then becomes is it still a hardship if the bill has been paid through other means, in this case a medical credit line or a credit card. 

The answer from the both the ASPPA panel and the IRS was that what triggered the eligibility for a hardship was the medical expense.  Whether the debt was already paid doesn't matter because it is the expense that is the hardship.

So, since costs related to the purchase of a primary residence is an eligible hardship under the safe harbor definition, does it matter that those costs first came out of the participants checking account if those costs could have been paid with the hardship distribution?

It will probably depend on the facts and circumstances, but I would not disqualify a participant just because they are looking to recover a payment they already made. 

Interesting. I was always taught that part of the hardship requirements was that there was no other way to pay for the expense. That line of credit may not be ideal, but it does sound like another way to pay for it. And in the long run, it may be cheaper than paying the taxes and early withdrawal penalty on the hardship.

[RatherBeGolfing]

23 minutes ago, K2retire said:

Interesting. I was always taught that part of the hardship requirements was that there was no other way to pay for the expense. That line of credit may not be ideal, but it does sound like another way to pay for it. And in the long run, it may be cheaper than paying the taxes and early withdrawal penalty on the hardship.

I dug up the Q&A to see what the written answer was.  It was part of the 2013 ASPPA Annual IRS Q&A. 

Quote

Q:

it seems like more and more hospitals and medical practices are going towards medical finance credit lines (such as Care Credit or MedMax) to secure payment rather than making a payment arrangement directly with the patient. I can’t really blame them, as it shifts the burden of collecting payments away from the hospital or practice. What is a bit unclear though, is how to handle such a charge when a participant requests a hardship distribution to make the payments on the medical finance credit line. Is it still considered an immediate and heavy financial need to pay for medical expenses? I think you could make the case that if a participant is granted such a medical credit line to pay for medical expenses, but can’t actually make the payments on the credit line, a hardship could be used to pay off the medical credit line. After all, the participant had no choice; it was either pay now or finance the charge in order to get the procedure. But what about when a participant comes to the plan sponsor 6-12 months after the charge has been applied to the credit line because they can no longer make their payments? Are they seeking a hardship to pay the underlying medical expense or are they paying off a credit card that just happens to be limited to medical expenses (that would otherwise qualify for a hardship)?

ASPPA Proposed Answer:

There is no requirement under the hardship portion of the 401(k) regulations relating to how the participant must pay his/her medical expenses. The nature of the expense controls its eligibility for hardship treatment (along with the other hardship requirements), not the manner in which the participant pays the expense.

IRS Response:

We agree with the proposed response

 

[CJS07]

Hi All,

When accessing funds for costs related to a primary residence - does this include refinancing and using say 80,000 from your 401k to pay down the principal on your house? I say no.

[MoJo]

20 hours ago, RatherBeGolfing said:

The fact that the hardship distribution "reimburses" an expense that has been paid does not necessarily mean that the hardship is no longer there or that the participant should not be able to utilize a plan feature.

For example, I have 2,000 disposable income until my next paycheck, of which I need at least $1,500 to cover expenses.  I end up with a medical emergency and I need to pay the hospital $1,000.  Knowing that my 401(k) plan allows for hardship distributions, I pay the $1,000 from my checking account and apply for the hardship to "reimburse" myself for the expense.  The medical bill has been paid, but without the hardship distribution, I can no longer cover my expenses.  Do I not have a hardship because I used the money in my checking account to pay for the bill?

I asked a similar question a few years back at the ASPPA annual IRS Q&A.  The issue was that most of the hospitals in my area are requiring payment for services before you leave the hospital instead of the old approach of a payment plan.  If you cannot pay your bill, they will set you up with something like MedMax, Care Credit, or some other type of financing.  In the end, the hospital is paid in full, and the patient walks out with an open line of credit that will take you to court and destroy your credit if payments are not made.

 

Interesting.  I've recently looked at this issue (to document the "need" the participant submitted medical bills - ALL OF WHICH were marked "PAID IN FULL" with a balance due of zero.  The problem with applying what you have above is that it REQUIRES a plan sponsor or service provider ro look beyond the four corners of the documentation to ascertain whether or not an immediate and heavy need exists.  Who wants to look at the family budget to determine that by paying the medical bills first their is a hardship created in the inability to continue paying ordinary expenses going forward?  How are we to determine that the participant didn't just have some extra cash laying around to pay the medical bills and now wants a hardship to provide cash for a trip to Disney?

I think the IRS' response, while generous, actually creates more questions that we as a service provider and plan sponsors would not like to have to answer.  Despite the "bills" being for allowable medical expenses, there STILL has to be some semblance of a "need" demonstrated (and yes, I know the safe harbor definition *only* requires a covered reason and no alternatives from the "plans" of the sponsor).

[RatherBeGolfing]

4 minutes ago, MoJo said:

Interesting.  I've recently looked at this issue (to document the "need" the participant submitted medical bills - ALL OF WHICH were marked "PAID IN FULL" with a balance due of zero.  The problem with applying what you have above is that it REQUIRES a plan sponsor or service provider ro look beyond the four corners of the documentation to ascertain whether or not an immediate and heavy need exists.  Who wants to look at the family budget to determine that by paying the medical bills first their is a hardship created in the inability to continue paying ordinary expenses going forward?  How are we to determine that the participant didn't just have some extra cash laying around to pay the medical bills and now wants a hardship to provide cash for a trip to Disney?

I think the IRS' response, while generous, actually creates more questions that we as a service provider and plan sponsors would not like to have to answer.  Despite the "bills" being for allowable medical expenses, there STILL has to be some semblance of a "need" demonstrated (and yes, I know the safe harbor definition *only* requires a covered reason and no alternatives from the "plans" of the sponsor).

I would limit the application to the safe harbor definition since just about anything could be a hardship in a plan that does not limit hardships to the IRS safe harbor.  The whole reason I ventured into this was because the medical expense became a consumer debt which would not be covered under the SH definition if we applied the "paid by other means" approach.

My example of the family budget was just to illustrate that a hardship / need still exists even though the bill was paid, I'm not suggesting that a PA (using the SH definition) would need to look beyond expense to justify the hardship.

Why do you think that the IRS creates more questions for us since you also stipulate that the SH definition "*only* requires a covered reason and no alternatives from the "plans" of the sponsor"?  To me that sounds like the buck stops at the covered reason.

[MoJo]

18 minutes ago, RatherBeGolfing said:

18 minutes ago, RatherBeGolfing said:

I would limit the application to the safe harbor definition since just about anything could be a hardship in a plan that does not limit hardships to the IRS safe harbor.  The whole reason I ventured into this was because the medical expense became a consumer debt which would not be covered under the SH definition if we applied the "paid by other means" approach.

My example of the family budget was just to illustrate that a hardship / need still exists even though the bill was paid, I'm not suggesting that a PA (using the SH definition) would need to look beyond expense to justify the hardship.

Why do you think that the IRS creates more questions for us since you also stipulate that the SH definition "*only* requires a covered reason and no alternatives from the "plans" of the sponsor"?  To me that sounds like the buck stops at the covered reason.

 

Yes, but....  Suppose the documentation is dated 11/1/2016 and the hardship request comes in 4/1/2017?  Or 6/1/2017?  Or later?  I've seen hardship request come in years after they were incurred (denied, mostly as a sham to get an early distribution).

Now, someone has a determination to make.  In the scenario I recently experienced, the participant was one of the top 5 dogs at the company, and the invoices had a "paid" date 5 months before the request.  Based on his salary (we looked), he earned many times more than the admittedly large medical bills during that time frame.  Does it matter?  Not my call.  The bottom line is we "rejected" it as not appropriate for our "hardship determination" outsourcing services simply because it didn't fit our "checklist" which required "documentation" that clearly spelled out the amount of the "need" (no way to determine if they were all marked "paid.").  In that scenario, it's up to the plan sponsor (who wasn't happy that the process wasn't "automatic" and that we had to get them involved), but we (as a service provider) are limited in the authority we have (and the information we get), and it required plan sponsor involvement.

Just a challenge.  That's all I'm saying.....

[Bird]

Shouldn't we be asking the original poster if the plan uses the safe harbor definition of hardship?  If so, then the purchase of a primary residence qualifies, period end of story.  It's hard for me to imagine that the participant is looking for so much money that they will get back a down payment plus various closing costs...plus the amount due to complete the purchase.

(If it doesn't use the safe harbor definition, then pretty much the same logic applies anyway; who is going to argue that the purchase of a home doesn't qualify?)

[RatherBeGolfing]

17 hours ago, MoJo said:

Yes, but....  Suppose the documentation is dated 11/1/2016 and the hardship request comes in 4/1/2017?  Or 6/1/2017?  Or later?  I've seen hardship request come in years after they were incurred (denied, mostly as a sham to get an early distribution).

Now, someone has a determination to make.  In the scenario I recently experienced, the participant was one of the top 5 dogs at the company, and the invoices had a "paid" date 5 months before the request.  Based on his salary (we looked), he earned many times more than the admittedly large medical bills during that time frame.  Does it matter?  Not my call.  The bottom line is we "rejected" it as not appropriate for our "hardship determination" outsourcing services simply because it didn't fit our "checklist" which required "documentation" that clearly spelled out the amount of the "need" (no way to determine if they were all marked "paid.").  In that scenario, it's up to the plan sponsor (who wasn't happy that the process wasn't "automatic" and that we had to get them involved), but we (as a service provider) are limited in the authority we have (and the information we get), and it required plan sponsor involvement.

Just a challenge.  That's all I'm saying.....

All good points, though I think those issues are there regardless of the position that the expense is all you need for the hardship.  

 

[MoJo]

On ‎6‎/‎1‎/‎2017 at 11:37 AM, RatherBeGolfing said:

All good points, though I think those issues are there regardless of the position that the expense is all you need for the hardship.  

The "reason" for the expense is easy - got a medical bill, you have a "hardship" reason by definition.  You still can't ever give out more than is required to satisfy the need, and that is where the issues arise with "funky" documentation.

[Mike Preston]

I don't have time to go into detail, but I think if you do enough research you will find that there are some fairly disturbing conclusions regarding the ability to reimburse a participant for charges already settled.  The most obvious circumstance is one where a credit card is used to pay for an emergency medical procedure and the participant immediately asks for a hardship in order to pay the credit card company.  Most of us, I would think, would say this qualifies.  However, there are some who disagree, and by some I mean the IRS and Treasury have at times disagreed.  Here is a cite to a fairly detailed hardship policy that appears to recognize the issue and makes a credit card exception only for "Medical Credit Cards" (whatever they are).

http://laborunions401k.com/wp-content/uploads/2014/10/Explanation-of-Hardship-and-Supporting-Documentation.pdf

I can't possibly see how reimbursement of funds deposited into escrow, whether due to closing costs or not, could possibly survive.