Question: Our third party administrator provides an electronic system for our 401(k) participants to make and change their deferral elections, choose and change investments, and request distributions, including requests for hardship distributions.
Can we avoid collecting any hardship-related documents from participants in our 401(k) plan by allowing them to certify electronically that they satisfy all requirements for a hardship distribution?
Answer: Unfortunately, not all of the hardship conditions can be met by self-certification. A 401(k) plan can make a hardship distribution only if the participant experiences an "immediate and heavy financial need" and a hardship distribution is "necessary to satisfy the financial need."
While the regulations allow a participant to self-certify that a requested distribution is the sole way to alleviate a financial need (that is, other resources are lacking), self-certification is not sufficient to show the nature of a hardship (in terms of the type and amount of the need).
Informally, the IRS has stated that a plan should obtain and maintain the following records in paper or electronic format for hardship distributions:
- Documentation of the hardship distribution request, review, and approval;
- Financial information and documentation substantiating the participant's financial need;
- Documentation to support that the distribution was properly made in accordance with the Code's hardship rules and applicable plan provisions; and
- Proof that the distribution was made and that Form 1099-R was filed reporting the distribution.
Self-certification can be used in lieu of collecting any information or documents about the participant's lack of other resources to meet the financial need.
Alternatively, a plan may use a safe harbor that uses information known to the sponsor and a minimum required suspension of deferrals to relieve the plan of having to collect documentation about the participant's lack of other resources.
These strategies address only whether the distribution is "necessary," and do not eliminate the need to document the nature of the participant's hardship. The plan must request and retain documentation such as bills or legal documents establishing the nature of the hardship.
In the IRS's view, not requesting and retaining documentation needed to substantiate a participant's financial hardship is an operational qualification failure that requires correction under the Employee Plans Compliance Resolution System.
Even when a third party administrator maintains hardship distribution records, it's ultimately the plan sponsor's responsibility to ensure those records are retained (in electronic or paper format) so that they are available to support the plan's decision in the event of an audit or dispute.