Hardship Tax Withholding Requirements

[401king]

We've come across some conflicting information regarding hardships and the default/options for federal tax withholding. 

Is it true that the default withholding is 10% of the Hardship amount? The result is that the default withholding will result in a check for 90% of the participant's requested hardship amount. 

If 10% is the default, is it required that the participant file a W4-P to either opt-out of tax withholding or elect an amount greater than 10%?

[ESOP Guy]

The default is 10%.

They can use a W4-P to elect out of withholding or ask for more. 

Our firm just puts the ability to do a withholding change on an RMD (or hardship) form we send that explains the RMD (hardship).  We make it clear that the "r" stands for required so they will get a check even if they do nothing.  My point is I have seen a number of firms just use the form as a substitute for the W4-P and never seen it be an issue. 

If pressed for time we have told plans to send the RMD and withhold 10%.  Since people are used to the 20% rule it is rare the get an objection even if it is for the wrong reason. 

 

Sorry, I got a little confused and started to write RMD a lot when the person asked about hardships which is the same basic answer. 

I didn't intend to cause confusion.  I guess I am still recovering from 5500 due date. 

 

[rr_sphr]

are you asking about withholding or the 10% early withdrawal penalty tax?  I am not finding anything that allows an "out" of the 20% mandatory federal wh tax?  https://www.irs.gov/retirement-plans/plan-participant-employee/401k-resource-guide-plan-participants-general-distribution-rules

Would you mind posting where you are finding anything that lets an employee opt out of the 20% automatic withholding? I've not seen it or heard of it on hardships unless it's part of the new law changes at 1/1/20

[Belgarath]

Mandatory 20% withholding is only applicable to "eligible rollover distributions." A hardship withdrawal is not an eligible rollover distribution.

[C. B. Zeller]

20% withholding is mandatory on eligible rollover distributions. 3405(c)

A hardship withdrawal is not an eligible rollover distribution. 402(c)(4)(C)

[ESOP Guy]

3 hours ago, rr_sphr said:

are you asking about withholding or the 10% early withdrawal penalty tax?  I am not finding anything that allows an "out" of the 20% mandatory federal wh tax?  https://www.irs.gov/retirement-plans/plan-participant-employee/401k-resource-guide-plan-participants-general-distribution-rules

Would you mind posting where you are finding anything that lets an employee opt out of the 20% automatic withholding? I've not seen it or heard of it on hardships unless it's part of the new law changes at 1/1/20

If you search for 20% in this publication https://www.irs.gov/publications/p575  

You will find the following:

If an eligible rollover distribution is paid to you, the payer must withhold 20% of it. This applies even if you plan to roll over the distribution to another qualified retirement plan or to an IRA. However, you can avoid withholding by choosing the direct rollover option, discussed later. Also, see Choosing the right option at the end of this discussion.

 

A hardship isn't eligible for a rollover distribution. 

[rr_sphr]

Interesting(I'm a plan sponsor, not a TPA or recordkeeper) ....I went back and looked at our last hardship only to find NO withholding was taken  - either 20% or 10%.  Then I looked at the hardship distribution form and it doesn't mention anything about tax consequences at all, nor does it allow the participant to request that any money be withheld. Nor did the participant fill out any form to NOT withhold.  Is this something I should be concerned about if our plan is not withholding anything on hardships without any direction from the participant?

My usual google prowess is giving me blanks for searching any type of mandatory withholding on hardships or what default should be.  Some places I am reading 20% and others it just says "income tax will be owed" type statements.

Just an aside, my link I found above uses the words "taxable distribution" not "rollover eligible distribution".....Totally agree it's 20% on the eligible rollover ones, but have yet to find a definitive on the hardship that isn't eligible for rollover.  It's just concerning me that my TPA/recordkeeper now hasn't withheld anything if 10% is the default.

[Kevin C]

C.B. gave you the cite for hardship distributions not being eligible for rollover:

 

Quote

 

402(c)(4) Eligible rollover distribution

For purposes of this subsection, the term "eligible rollover distribution" means any distribution to an employee of all or any portion of the balance to the credit of the employee in a qualified trust; except that such term shall not include—

(A) any distribution which is one of a series of substantially equal periodic payments (not less frequently than annually) made—

(i) for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of the employee and the employee's designated beneficiary, or

(ii) for a specified period of 10 years or more,

(B) any distribution to the extent such distribution is required under section 401(a)(9), and

(C) any distribution which is made upon hardship of the employee.

If all or any portion of a distribution during 2009 is treated as an eligible rollover distribution but would not be so treated if the minimum distribution requirements under section 401(a)(9) had applied during 2009, such distribution shall not be treated as an eligible rollover distribution for purposes of section 401(a)(31) or 3405(c) or subsection (f) of this section.

 

The part about 10% withholding on a hardship distribution unless the participant elects otherwise is in 3405(b).

Quote

 

3405(b) Nonperiodic distribution

(1) Withholding

The payor of any nonperiodic distribution (as defined in subsection (e)(3)) shall withhold from such distribution an amount equal to 10 percent of such distribution.

(2) Election of no withholding

(A) In general

An individual may elect not to have paragraph (1) apply with respect to any nonperiodic distribution.

(B) Scope of election

An election under subparagraph (A)—

(i) except as provided in clause (ii), shall be on a distribution-by-distribution basis, or

(ii) to the extent provided in regulations, may apply to subsequent nonperiodic distributions made by the payor to the payee under the same arrangement.

 

You should be concerned about not doing the correct withholding on hardship distributions.  It may not come back to bite you, but it should be done correctly going forward.

 

[Luke Bailey]

3 hours ago, rr_sphr said:

Interesting(I'm a plan sponsor, not a TPA or recordkeeper) ....I went back and looked at our last hardship only to find NO withholding was taken  - either 20% or 10%.  Then I looked at the hardship distribution form and it doesn't mention anything about tax consequences at all, nor does it allow the participant to request that any money be withheld. Nor did the participant fill out any form to NOT withhold.  Is this something I should be concerned about if our plan is not withholding anything on hardships without any direction from the participant?

My usual google prowess is giving me blanks for searching any type of mandatory withholding on hardships or what default should be.  Some places I am reading 20% and others it just says "income tax will be owed" type statements.

Just an aside, my link I found above uses the words "taxable distribution" not "rollover eligible distribution".....Totally agree it's 20% on the eligible rollover ones, but have yet to find a definitive on the hardship that isn't eligible for rollover.  It's just concerning me that my TPA/recordkeeper now hasn't withheld anything if 10% is the default.

You should give them a W-4P or provide electronic equivalent and they can choose whether to have 10% or some other amount withheld. As some of the responses above point out, under Section 3405(a)(1) the plan administrator is required to withhold 10% unless the participant elects no withholding or a different amount.

[rr_sphr]

thanks!!!