Hardship Dist... taxes

I have a participant who has a legit hardship.  His wife has become disabled.  The medical and credit card bills are getting out of hand because his state is dragging their feet with any state benefits.  Simple question... just want to be sure... it's just like any other distribution, correct?  Taxes need to be withheld (20%).   The 1099-R will be coded properly and if there is no exception he will pay the excise tax when he does his personal taxes.  

Am I correct?  Missing anything? 

Thanks

Hardships have a 10% default federal withholding but you can opt out and elect a lower percentage, even 0%, or can elected a higher percentage if you want. But Hardships are not eligible for rollover and therefore not subject to the mandatory 20% federal withholding.

Further, a plan might allow a hardship distribution “of the amount required to satisfy the financial need (INCLUDING any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution).”

26 C.F.R. § 1.401(k)-1(d)(3)(iii)(A) https://www.ecfr.gov/current/title-26/part-1/section-1.401(k)-1#p-1.401(k)-1(d)(3)(iii)(A)

For example, imagine a participant’s four marginal tax rates for Federal, State, and municipal income taxes, including the Federal too-early tax (10%), sum to 50%. (To simplify, let’s assume the participant and her spouse each has only one residence, and both work only in that same city or county.) Anticipating a combined 50% marginal income tax rate allows a distribution amount that’s double the hardship need. Remember, taxes will apply on the grossed-up distribution.

Because an employer/administrator does not know everything about its worker’s and her spouse’s income and other elements of one’s tax situation, a plan’s administrator might accept a participant’s written statement, under civil and criminal false-statement penalties, about taxes “reasonably anticipated” if that estimate is within a zone of plausibility.

Thanks!  I didn't know the Hardship wasn't automatically subject to 20%.  So I guess I should ask the participant what % they want to have withheld? 

Also... his deferrals are all Roth.  I need to look into that and understand the tax complications there.  

You should send a W-4R form with all of your distribution paperwork for nonperiodic payments so the participants can make their withholding election.  The form explains when 10% and 20% are the default options and allows them to choose less than 10% for the applicable distributions or more than 20% for the applicable distribution types.  The form also includes some basic tax calculators.

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-hardship-distributions

See also https://www.planadviser.com/reminder-avoid-fraudulent-hardship-withdrawals/

https://www.irs.gov/retirement-plans/its-up-to-plan-sponsors-to-track-loans-hardship-distributions

Roth Account...

This partisipant has 4 different money pools:

• PS
• SH
• Pre-Tax Deferral
• Roth Deferral

The plan document says that we can pull money from all plan accounts to complete this hardship distribution.  In my mind I feel it would be best to preserve the Roth deferral account and pull all of the money needed to complete the hardship distribution from the other 3 accounts.  

Make sense?  Any reason I shouldn't?

Should the claim form require or permit a claimant to specify one’s preference (within what the plan allows) about which subaccounts to draw from in which order?

And if the form does not require a claimant to specify one’s preference, should the form state a default order that applies if the claimant does not specify the claimant’s preference?

The form doesn't require the claimant to indicate from which money pool the distribution should come from nor did he indicate his desire.

The form dose not state a default.  

As Pam Shoup suggested, I have completed a W-4R form for him to sign. 

I think I'm good 🙂... yes?

Look beyond the distribution paperwork and look at the plan document.  Most pre-approved plan documents have several sections addressing hardships.  These sections answer questions like:

• which accounts are available (and under what circumstances)?
• is there an order in which accounts are accessed?
• are hardships limited to specific events?
• does the employee have to take an available loan before taking a hardship distribution?

The documents are Cycle 3 documents.  Note that the Bipartisan Budget Act of 2018 required certain changes to plan provisions related to hardship distributions. Final regulations were effective on or after 1/1/2020 and plans had to be amended to include the changes by 12/31/2021.  Most pre-approved plans provided an Interim Amendment that added the required hardship amendments. Some of the new provisions were optional, so the Interim Amendments may or may not have modified the provisions in the original text of plan document. The Interim Amendments were very lengthy and often included a menu of choices for each provision.

• check to see if any Interim Amendments modified the plan provisions.

All of this was happening during the pandemic, and a plan easily may have continued to use distribution paperwork and related procedures that do not reflect the plan documents and related amendments.

On another note, if the plan is using a recordkeeper, the recordkeeper may have default hardship provisions in its service agreement that may or may not align with the plan document as amended.

If copies of the plan document and the Interim Amendments are available, it should take less than a half-hour to confirm the answers to any questions.

The document is a Wolters Kluwer document.  I reached out to support and they promptly provided the language in the document that steered me in the right direction.  

Thanks for the response!

As to the W-4P.

Did the distribution paperwork not include a section on withholding?  Most of the forms I've seen have a section on taxes where they can elect more than 20% or any percentage if the withdrawal is not eligible for rollover.

If so, I don't send a W-4P and just use the form.

Internal Revenue Code § 401(k) does not preclude a plan from providing a hardship distribution grossed-up for reasonably anticipated income taxes, even if the distributee instructs zero withholding.