How does a client handle an ineligible Hardship Request?

[effingeh]

Hello!

Client has a plan with self-certification of hardships. All requests are automatically approved based on employees "signing off" that they have the required proof of hardship. Client did an audit and found an employee was abusing this, contacted them, and found that they have been taking Hardships without any immediate need.

Client is looking for guidance on how to correct this. Initial thought was that the employee should repay what was taken that didn't have proof, however, the legal team at the provider stated that this wasn't allowed. They were given the following:

"The sponsor of a retirement plan that allows hardship distributions cannot reclaim a hardship distribution after it has been disbursed to the participant. Rather, the sponsor can refuse to approve a hardship request prior to distribution if the participant is deemed not to have an immediate and heavy financial need or if the sponsor has actual knowledge that the participant's self-certification of hardship is false.
The plan sponsor does not have the authority to "reclaim" money already distributed because hardship distributions are subject to taxes and potentially a 10% penalty. Reclaiming the money would essentially be canceling an early withdrawal, which isn't permitted under IRS rules after the funds have been paid out."

Is this correct? I feel like I have seen this done at other places I have worked.

If this is allowed, and the participant does not work with the client to pay back the funds, what should be done in that case?

Thanks in advance for any responses.

[ratherbereading]

https://www.plansponsor.com/fraudulent-hardship-withdrawals-draw-grand-jury-ire/

[Peter Gulia]

About the hyperlinked article and the court decision it explains, neither says that anyone other than the participant did anything wrong.

[effingeh]

Thank you both for your responses - Are either of you able to answer/give your opinion on the following?

1 - Is the employee allowed to pay back these funds? Or was the statement made about this not being allowed correct?

2 - Assuming the funds aren't paid back (which is expected), should any updates be made to the 1099-R?

[Paul I]

It would seem that the withdrawal could be considered an overpayment from the plan, and the rules of EPCRS procedures for overpayments would allow plan administrator to ask for the return of the withdrawal.

A hardship withdrawal cannot be rolled over, so the withdrawal when originally paid would have been treated as a taxable distribution reported on a 1099R with a code that indicates if it was subject to an early distribution penalty.  If the 1099R was not yet sent out, it would take communicating with the 1099R preparer on what gets reported.  If the 1099R was sent or if the preparer refuses to cooperate, then the participant will have to file a request with the IRS to recoup the taxes and penalty.

If the funds aren't paid back, the plan administrator can choose not to recoup the amount.

The plan administrator should work with the recordkeeper/TPA to take steps to prevent this participant from taking a hardship withdrawal with out an approval from the plan administrator.

The employer also may wish to have a discussion with the participant about possible disciplinary action for lying and taking money out of the plan under false pretense.

Just some thoughts.

[fmsinc]

One has to wonder what idiots came up the concept of a self-certification.  Create a rule that can be circumvented and people will do just that. When it comes to Military Survivor Benefit Plan ("SBP") annuities if the Former Spouse remarries before age 55 the entitlement to the SBP is suspended (not terminated as is the case with CSRS and FERS) but may be reinstated if the marriage ends in divorce of the death of the new spouse.  So guess what happens?  The Former Spouse remarries before age 55, then divorces the new spouse before age 55  and remarries after age 55.  How easy is that?  

In Brown v. Continental Airlines, Inc., 647 F. 3d 221 (5th Cir., 2011) -  
https://scholar.google.com/scholar_case?case=4019345202025914766&q=brown+v.+continental+airlines&hl=en&as_sdt=20000003
Continental alleged that a number of pilots and their spouses obtained "sham" divorces for the purpose of obtaining lump sum pension distributions from the Continental Pilots Retirement Plan that they otherwise could not have received without the pilots' separating from their employment with Continental.  The pilots were allegedly acting out of concern about the financial stability of Continental and the fear that the Plan might be turned over to the PBGC and that their retirement benefits would be substantially reduced.

By divorcing, the pilots were able to obtain QDROs from state courts that assigned 100% (or, in one instance, 90%) of the pilots' pension benefits to their respective former spouses.  The Plan provides that, upon divorce, if the pilot is at least 50 years old (as all the pilots in this case were), a former spouse to whom pension benefits are assigned can elect to receive those benefits in a lump sum even though the pilot continues to work at Continental.  The former spouses presented the QDROs to Continental and requested payment of lump-sum pension benefits.  After the former spouses received the benefits, the couples remarried.  

Continental sought to obtain restitution under ERISA Section 502(a)(3).  The Court of Appeals noted that ERISA § 206(d)(3) limits the QDRO qualification determination to whether the state court decree calls for benefit payments outside the terms of the Plan.  It rejected Continental’s expanded reading of §206, concluding that plan administrators may not question the good faith intent of Participants submitting QDROs for qualification. 

In my area of pension and retirement law, preparing QDROs, I regularly see Participants taking maximum loans and self certified hardship distributions to reduce the amount in the Plan available to a prospective Alternate Payee.  

So either get rid of self certification or expect to be played.  

 

 

[ratherbereading]

15 hours ago, effingeh said:

Thank you both for your responses - Are either of you able to answer/give your opinion on the following?

1 - Is the employee allowed to pay back these funds? Or was the statement made about this not being allowed correct?

2 - Assuming the funds aren't paid back (which is expected), should any updates be made to the 1099-R?

I can't add anything else - but we did fire a client once because the owner took an illegal hardship distribution. 

[Belgarath]

I have to say, ignoring the possible deleterious effects on long-term fiscal or social policy, as a TPA, I LOVE self-certification. 

[C. B. Zeller]

On 10/7/2025 at 4:54 PM, fmsinc said:

One has to wonder what idiots came up the concept of a self-certification.

Conversely, one might wonder what idiot came up with the idea of auditing something that you don't need to. Congress and the IRS have given plan administrators explicit permission to rely upon participant self-certification of hardships, unless they have actual knowledge to the contrary. So why would the plan administrator go looking for trouble when they had no duty to do so, nor liability for not doing so? There can be no good that comes from this, only problems.