Human Resources News & Insights

IRS clarifies 401(k) distribution rules: What plan sponsors need to know

Even if you use a third-party administrator for your retirement plan, you need to pay attention to what the IRS just published. 

Employee Plan News is a somewhat bare-bones newsletter the IRS uses to provide guidance and news to plan sponsors and administrators, and in its April 1, 2015 issue, it said that recent audits have revealed that retirement plan administrators are making some mistakes.

As a result, the IRS tried to clarify some recordkeeping, hardship distribution and plan loan rules.

A warning to plan sponsors

To kickoff the newsletter, the IRS said that using a third-party administrator won’t protect plan sponsors if mistakes are made in the administration of their plans.

Bottom line: Plan sponsors are ultimately responsible for how their plans are run.

So plan sponsors will want to make sure the following requirements are being met.

Hardship documentation

When it comes to hardship loans, the IRS said plans must retain these records for examination, should an audit need to be conducted (it’s not sufficient for plan participants, alone, to retain these records):

  • documentation of the hardship request, review and approval
  • financial information and documentation that substantiates the employee’s immediate and heavy financial need
  • 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.

Self-certification is not enough

The IRS went on to say that audits have revealed some administrators are mistakenly allowing plan participants to self-certify that they satisfy the criteria to receive a hardship distribution.

Instead, administrators must request and retain documentation to show the existence and the nature of the hardship — such as a principal residence purchase agreement or receipts for medical care or funeral expenses.

The IRS did, however, say that self-certification is permissible for a participant to show that a hardship distribution is the sole way to alleviate a hardship.

Plan loan documentation

When it comes to plan loans, the IRS said plan sponsors must retain these records:

  • evidence of the loan application, review and approval process
  • an executed plan loan note
  • documentation, if applicable, verifying that the loan proceeds were used to purchase or construct a primary residence
  • evidence of loan repayments, and
  • evidence of collection activities associated with loans in default and the related Forms 1099-R, if applicable.

Loans in excess of five years

If a participant requests a loan with a repayment period in excess of five years for the purpose of purchasing or constructing a primary residence, the IRS says the plan sponsor must obtain documentation of the home purchase before the loan is approved.

What about self-certification?

Much like with hardship distributions, the IRS says allowing participants to self-certify their eligibility for these loans is impermissible.

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