Basic Test: Immediate and Heavy Financial Need and Distribution Is Not In Excess of Amount Needed
A hardship distribution from a participant’s elective deferrals account can only be made if the distribution meets the following two tests:
- The distribution is on account of an immediate and heavy financial need; and
- The distribution is not in excess of an amount necessary to satisfy that financial need.
Hardship distributions can only be made from accumulated elective deferrals, not from earnings on elective deferrals.
Does Plan Allow Hardship Distributions?
You must contact the plan sponsor or plan administer to determine if the plan allows hardship distributions and request to see a copy of the plan document to know the particular hardship provisions of your plan as drafted by the plan sponsor.
What is An Immediate and Heavy Financial Need
Under IRS rules, a distribution is deemed necessary to satisfy an immediate and heavy financial need of an employee if all of the following requirements are satisfied:
- The distribution is not greater than the amount of the employee’s immediate and heavy financial need. This may include any amounts necessary to pay any federal, state or local income taxes or penalties reasonably anticipated to result from the distribution;
- The employee has obtained all distributions, other than hardship distributions, and all nontaxable (at the time of the loan) loans currently available under all of an employer’s plans, and
- The terms of the plan prohibit the employee from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least six months after the hardship distribution.
IRS Safe Harbors For Determining If a Hardship is Present
In addition, the IRS rules provide the following “safe harbors” for determining if a hardship distribution is on account of an immediate and heavy financial need:
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Expenses for medical care previously incurred by the employee, the employee’s spouse, dependents or beneficiary or is now necessary for these persons to obtain medical care;
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Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments);
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Tuition, related educational fees and room and board expenses for the next 12 months of post-secondary education for the employee, or the employee’s spouse, children, dependents or beneficiary of the employee;
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Payments necessary to prevent the eviction of the employee from the employee’s principal residence or mortgage foreclosure;
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Funeral expenses for the employee, the employee’s spouse, children, dependents, or beneficiary of the employee; or
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Certain damage repair expenses for the employee’s principal residence.
No Payback and No Contribution for Six Months
Generally, employees who take a hardship distribution cannot repay it back to the plan and in most cases are not permitted to contribute to the plan for six months after the withdrawal. A review of the provisions of the plan should be made to know the exact provisions of your particular hardship withdrawal features.
Income Tax and 10% Additional Tax
Hardship withdrawals are subject to income taxes and a 10% additional tax on early distributions.
Alternative to Hardship Distribution: Plan Loan
If the plan allows for plan loans, this may be a viable alternative to a hardship distribution. This may be preferable if the participant wants to pay back the amount withdrawn from the plan.
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Paul Voss, posted May 19, 2011
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