By: David I Gensler, MSPA, MAAA, EA
In April of 2015, in an article in the IRS publication Employee Plan News (yes, there really is such a publication) they clarified that when taking a hardship withdrawal, that it was not sufficient for certain third party administrators (TPAs) to rely on plan participants to keep copies of the documents that proved a hardship withdrawal was due to “an immediate and heavy financial need.” Documents like the explanation of benefits for medical expenses, the purchase agreement for a participant’s primary residence and/or an invoice for funeral expenses are all examples of the paperwork that the TPA should collect before granting a hardship withdrawal. The IRS further stated that, when examining a plan under audit, the failure of the TPA to keep their own independent records was a plan qualification issue. Whenever the qualification of the plan is at risk, the topic gets my attention.
In my opinion, most retirement plans fall into two separate categories. For small to medium size companies there generally is a division of responsibilities between the recordkeeping firm and the TPA firm. These arrangements are known as “unbundled” solutions and in those cases, the TPA firm and the client work together to ensure that the appropriate hardship withdrawal documentation is provided. My firm, Madison Pension Services, functions as the Plan Sponsor’s back office in this capacity, making sure that the participant provides the appropriate documentation to us, prior to our reaching out to the recordkeeper to release the hardship withdrawal.
Larger plans that seek to streamline the administration of their 401(k) plan typically opt for a “bundled” solution where the recordkeeping firm also provides TPA services. In the bundled world, participants generally go online for loan and hardship withdrawals. So there is no one verifying the hardship documentation. The participant is, in effect, self-certifying their distribution and it is these particular situations that the IRS seeks to remedy.
If four requirements are met, the TPA for a bundled retirement plan can be treated as meeting the hardship substantiation requirements, without obtaining and retaining the source documents from the participants, if:
- The participant receives a notice about certain hardship rules and agrees to retain and make the source documents available upon request. In most cases, that can be done via an email to the participant
- The TPA obtains from the participant a summary of information which should contain:
- The total cost of the hardship
- The amount requested
- A certification by the participant that the information is true and accurate
- The summary from the participant must include details about how the costs were incurred, who incurred them and who will be
- The TPA must have a process by which it annually provides or gives the employer access to data on hardship withdrawals.
- The plan must have a procedure in place whereby participants do not receive more than two hardship withdrawals per year. (But the memorandum then immediately says that more than two hardship withdrawals per year are acceptable if there is an adequate explanation. Follow up medical examinations and/or quarterly tuition payments are examples of adequate explanations).
If your plan was picked up for an IRS audit, under the terms of the Memorandum, the IRS examiner would review the summary of information, rather than the source documents. They would request the actual source documents only if the information contained within the summary was inconsistent or insufficient.
If a plan is not using the summary of information approach or if one of the four requirements is not met the IRS examiner will audit source documents to determine whether a hardship was made “on account of a deemed immediate and heavy financial need.”
So if you are a plan sponsor that uses the bundled approach and your plan document allows for hardship, make sure that your TPA firm is following the steps in the IRS Memorandum. Or the IRS can declare that this operational failure disqualifies the plan. That is a result that you want to avoid at all costs.