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IRS Updates How to Address Improperly Made Hardship Distributions

Technical Resources

The IRS has updated the content in its 401(k) Plan Fix-It Guide that addresses what to do when hardship distributions were not made properly.

The IRS makes recommendations regarding how to find and correct a mistake in providing hardship distributions.

How to Find the Mistake

  • Review your plan document to determine if it allows hardship distributions, and review the plan’s procedures.
  • Review all distributions made during the year and determine which may have been a hardship distribution.
  • For each hardship distribution, make a determination whether each one met the hardship distribution requirements in the plan document.
  • Look for abuse of the hardship feature; consider that if most hardship requests come from a specific group, some participants may be abusing the feature.

Fixing the Mistake

  • Establish procedures for reviewing hardship applications if there are none.
  • If the plan document doesn't allow for hardship distributions, but, in operation, hardship distributions do occur, correction may involve retroactively amending the plan in order to allow hardship distributions.
  • If hardship distributions are made to participants that don’t meet the plan document hardship requirements or the 401(k) rules, then correction may involve a repayment to the plan of the amounts that didn’t meet the plan hardship requirements or the provisions of Code Section 401(k).
  • The IRS also points out that self-correction is possible through its self-correction program, its voluntary correction program and the audit closing agreement program.

How to Avoid the Mistake

  • Review the plan document language to determine when and under what circumstances distributions can be made.
  • Make certain the language for hardship distributions is in the most recent document.
  • Establish hardship distribution procedures working with a benefits professional to determine if these procedures are sufficient to avoid mistakes.
  • Only allow hardship distributions that meet the plan document and Section 401(k) requirements.
  • Look for signs that the hardship distribution program is being abused or badly managed. These may include:
  1. 1. Too many hardship requests by one group or division.
  2. 2. Requests for hardship distributions from multiple employees that appear identical.
  3. 3. Only the highly compensated employees have hardship distributions.