Processing Hardships. Agenda. Has it Become a Hardship Itself?

Transcription

1 Processing Hardships Has it Become a Hardship Itself? Agenda Legal & Regulatory Requirements Documentation Requirements Recent Commentary From the IRS 2 1

2 Legal and Regulatory Requirements Hardship Distributions From 401(k) Plan Three primary requirements: The distribution amount cannot exceed the amount of the need (or, if less, the total deferrals not including earnings after 7/1/89) The distribution must be on account of an immediate and heavy financial need The distribution must be necessary to satisfy that need No exception to 10% premature distribution penalty tax Not eligible for rollover 4 2

3 Maximum Amount A distribution cannot exceed the amount of the need However, the distribution amount may be grossed up to include income taxes and penalties reasonably anticipated For example, I need $20,000: 10% penalty tax, 25% state and federal tax I can take roughly $30,000 as a distribution (to net $20,000) 5 Immediate and Heavy Financial Need Determined based on all relevant facts and circumstances Analysis focuses on the type of event/expenditure Paying funeral expenses for a family member: yes Buying a boat or television: no 6 3

4 Immediate and Heavy Financial Need: Safe Harbor The regulations deem a distribution to be on account of an immediate and heavy financial need if it is for one of six reasons Three are for participant only: 1. Costs directly related to purchase of the participant s principal residence (not mortgage payments!) 2. Amount necessary to avoid eviction from or foreclosure on participant s principal residence 3. Expenses for casualty loss to participant s principal residence (in a presidentially declared disaster area) 7 Three Events for Broader Group 4. Medical expenses of the employee, spouse, dependent or beneficiary (disregard 7.5% AGI floor) 5. College tuition, room and board and related expenses for employee, spouse, children, dependents or beneficiary (12-months) 6. Funeral expenses for deceased parent, spouse, child, dependent, or beneficiary Beneficiary hardship is not mandatory (per PPA) 8 4

5 Tax Reform Change The tax reform legislation (the Tax Cuts and Jobs Act) changed the rules for casualty losses to the participant s principal residence: Prior Law: Allows hardship distributions for immediate and heavy financial need resulting from principal residence casualty losses that are deductible under Code 165 (even if < 10% of AGI) New Law: The casualty loss must be a result of a presidentiallydeclared disaster 9 Necessary to Satisfy the Need The participant has no other means reasonably available Based on relevant facts and circumstances Participant resources deemed to include: Own assets Assets of spouse or minor children that are reasonably available

6 Possible Sources to Satisfy Financial Need Plan should consider whether the participant has other sources of funding or assets to satisfy the financial need: Insurance (health or property/ casualty) Sale of assets Cessation of deferrals into the plan Distribution of plan assets (to the extent permitted by the plan) Participant loans* Commercial loans *Eliminated for PYs starting after 12/31/18 11 Participant s Written Representation Is Acceptable The 401(k) regs allow the Plan Administrator to reply on the participant s written representation that the financial hardship (need) cannot be satisfied from the sources listed on prior slide Unless the PA or ER has actual knowledge to the contrary Only applies for the limited purpose of verifying the necessity not the need itself Makes sense can t prove the negative No gold or $ under the mattress Undisclosed accounts 12 6

7 Necessary to Satisfy the Need Safe Harbor (no proof of need required) Employee has taken all available loans and distributions under any employer plan (except to the extent that it would be counterproductive); and Suspend deferrals for six months following hardship distribution This requirement has been eliminated for plan years beginning after 12/31/18 (per the Bipartisan Budget Act of 2018) Hardship Distributions Six-Month Suspension of Deferrals Treasury Regulations require that recipients of hardship distributions be prohibited from making salary deferral contributions to any plan of the employer for at least six months after receipt of the hardship distribution Must be part of plan terms or other enforceable agreement Treas. Reg (k)-1(d)(iv)(E)(2) How do deferrals restart: Automatically after six months? Upon participant action after six months? What does the plan say? Not required for PYs starting in

8 Hardship Sources Hardship distributions have historically been limited to the aggregate amount of an employee s elective deferrals (not adjusted for gains/losses) Effective for Plan Years beginning after 12/31/18, ERs can permit hardship distributions from other sources (NECs, QNECs, QMACs, earnings) 15 IRS Hardship Distribution Relief for Harvey, Irma Maria, California Wildfires Qualified plan or 403(b) plan can make hardship distribution to affected employee Only plans that can make hardship distributions not pension plans Governmental 457(b) plan can make unforeseeable emergency distribution to affected employee Whether or not: Plan has hardship language Plan recognizes this hardship No hardships from QMACs or QNECs or deferral earnings Can rely on employee s reasonable representations of hardship need and amount No need for 6-month deferral suspension 16 8

9 Qualified Hurricane Distribution Qualified hurricane distribution Distribution from eligible plan Between disaster date and December 31, 2018 To qualified individual Could be beneficiary Limit: $100,000 No 10% penalty Distributable event 3-year rollover option Can spread tax over 3 years 17 Hardship Case Studies 18 9

10 Case Study: Hardship Eligibility Harry requests a hardship distribution from the HDL Corp 401(k) Plan. Harry satisfies the need and necessity requirements and is issued a distribution Scenario #1: It is subsequently discovered that the Plan does not permit hardship distributions Scenario #2: It is subsequently determined that Harry was eligible to take a plan loan that would have been sufficient to meet his needs Scenario #3: Harry is a >5% shareholder. The plan is amended to allow hardship distributions based on Harry s request, employees are never informed, and is amended again two months later to eliminate hardships. Only Harry received a hardship distribution. 19 Case Study: Hardship Distributions Helene requests a $20,000 hardship distribution from the Zoo Corp 401(k) Plan Helene provides the PA copies of medical bills for her daughter and provides the PA with a statement that a hardship distribution is necessary to pay the bills Two weeks later the PA discovers (overheard at the water-cooler) that the medical bills had already been paid and Helene intended/used the hardship proceeds to buy a boat What should the PA do in response to this revelation? 20 10

11 Case Study: Suspension of Deferrals Scenario #1: Joffrey receives a hardship distribution from the Baratheon 401(k) Plan on 3/15/17. In early 2018, it was discovered that Joffrey s 401(k) deferrals were never suspended Scenario #2: Joffrey s deferrals are properly suspended as of 3/15/17, but his deferrals were not resumed as of 9/15/17 21 Permissible Hardships For safe-harbor and non-safe harbor hardship distributions, which of these are permissible: Expenses for the participant to travel to his/her parent s funeral? Expenses to repair a crack/leak in the foundation of the participant s principal residence? Expenses to repair water damage to the participant s principal residence from a flood (river/creek)? Expenses to repair fire damage to property that the participant rents? A vacation home? Payment of past due mortgage balance for participant s home after receiving a late notice? Prepayment of participant s daughter s four-year college tuition (to take advantage of discount)? 22 11

12 Documentation Requirements Documented Proof of Hardship Event (Heavy and Immediate Financial Need) Historically, practitioners have been confused about whether a participant needed to provide (and the Plan Administrator needed to retain) documentation proof of the hardship IRS traditionally indicated that the answer was yes participant certification was not permissible to show that the hardship event occurred

13 Hardship Documentation Requirements The plan sponsor should always retain these records in paper or electronic format: Documentation of the hardship request, review and approval; Financial information and documentation that substantiates the employee s immediate and heavy financial need (if the employee provides this, rather than using substantiation guidelines); Documentation to support that the hardship distribution was properly made in accordance with the applicable plan provisions and the Internal Revenue Code; and Proof of the actual distribution made and related Forms 1099-R 25 Change in IRS Policy Substantiation Guidelines In an internal IRS memorandum, auditors were told that there are two ways to demonstrate that the recipient of a hardship distribution had an immediate and heavy financial need: Obtain and retain source documentation from the participant New procedure: Plan Administrator provides mandatory disclosures to participant, who keeps the substantiation information Plan Administrator and participant must answer questions listed by IRS on audit

14 Change in IRS Policy Substantiation Guidelines Under new procedure: Recipient agrees to retain source documents and provide them on request If TPA obtains summary, TPA provides employer with report or other access to the data, at least annually, describing the hardship distributions during the year If any participant gets more than two hardship distributions/year, absent a reasonable explanation auditor can ask for original documents Must receive IRS supervisor approval first Immediate and Heavy Financial Need The IRS specified the information that must be collected for each of the six safe harbor need categories If the PA or service provider collect the documents, the documents must include the required information If the PA or service provider collects summary information, that party must: Collect and maintain the summary information, provide the participant a notice, and the participant is must maintain the records and produce them upon IRS request 28 14

15 New Guidance Notice Requirements PAs relying upon the new guidelines must provide to the employee notice of the following: The distribution is taxable and additional taxes ( 72(t)) may apply The amount of the distribution cannot exceed the immediate and heavy financial need Hardship distributions cannot be made from earnings, QNECs, or QMACs The recipient must preserve the source documents and make them available at any time, upon request, to the ER or PA 29 Summary Information Required For all requests: Participant s name Total cost of the hardship event Amount of distribution requested Certification by the participant that the info is true and accurate 30 15

16 Specific Info for Deemed Hardships For Medical Expenses: Who incurred the expense? Relationship to the participant Purpose of the medical care (diagnosis, treatment, prevention, L/T care ) Name and address of the service provider Amount of medical expenses not covered by insurance The IRS Memorandum lists the info required for other deemed hardships See TE/GE Statute of Limitations Generally: Three years from date Form 5500 is filed ERISA requires records supporting all information on the Form 5500 to be maintained for at least six years from the date the Form is filed Practically speaking, nearly eight years from the first day of the PY All relevant records should be maintained for at least six years from the date the Form 5500 was filed 32 16

17 Disaster Relief Hurricane/Storm Relief Announcement : Victims of Hurricane Matthew Announcement : Victims of Louisiana Storms Announcement : Victims of Hurricane Harvey Announcement : Victims of Hurricane Irma Announcement : Victims of Hurricane Maria and California wildfires Individuals entitled to relief: Employee or former employee Primary home or place of work on date of disaster in disaster area: Employee Spouse Descendant Ancestor

18 Hurricane/Storm Hardship Distribution Qualified plan or 403(b) plan can make hardship distribution to affected employee Excludes pension plans Normal rules about source of distributions (no earnings on deferrals, QNECs, QMACs) Governmental 457(b) plan can make unforeseeable emergency distribution to affected employee Whether or not: Plan has hardship language Plan recognizes this hardship Can rely on employee s reasonable representations of hardship need and amount No need for six-month deferral suspension 35 Hurricane/Storm Procedural Relief Don t have to follow all plan procedures: If spouse can t be located, don t wait for death certificate Take care of paperwork ASAP Applies to plans and IRAs Applies to distributions and loans Plan amendment may be needed to authorize loan/ distribution if document doesn t already authorize them Extended adoption deadline: end of 2017 plan year End of the 2018 PY for 2016 disasters (per tax law) No need for amendment to change hardship rules; just authorize hardships 36 18

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