David J. Kupstas, FSA, EA, MSEA Chief Actuary
Note: This article was published in 2015. The SECURE 2.0 Act of 2022 made changes to the rules relating to an employer's ability to rely on an employee's self-certification of the need for a hardship distribution. As such, some information in this article may be outdated.
Many 401(k) plans allow participants to take hardship withdrawals if there is an immediate and heavy financial need. A question is, should a participant have to prove there is hardship, or should plan sponsors simply take the participant’s word and grant the distribution?
It would seem to be a no-brainer that participants should have to provide at least some minimal documentation to substantiate the financial need. Otherwise, what’s to stop a dishonest worker from taking money from his 401(k) any old time? (Or an honest worker who just has a looser definition of “hardship” than you and me?) In a recent Employee Plans News article, the IRS wrote exactly that: electronic self-certification is not sufficient documentation of the nature of a participant’s hardship. “While self-certification is permitted to show that a distribution was the sole way to alleviate a hardship, self-certification is not allowed to show the nature of a hardship,” the IRS wrote. “Self-certification” refers to when a participant can get a hardship distribution by going on to a website and doing nothing more than checking a box attesting that a need exists.
Fidelity investments is taking a different view. In a posting on its website, Fidelity takes the IRS to task for basically coming up with its interpretation out of whole cloth. “This position does not appear to be supported by IRS regulations and is contrary to recent indications from IRS representatives suggesting that such documentation is not required,” according to Fidelity.
In hardship situations, there are two questions: (1) Is there a need? and (2) Is taking a hardship withdrawal from the 401(k) the only way the need can be satisfied? It is clear that the plan sponsor may rely on the employee’s word for question 2. It says so in the regulations. It is not as clear whether the plan sponsor may rely on the employee’s representation about whether an immediate and heavy financial need exists to begin with.
It just so happens that this very issue is on the IRS’ Priority Guidance Plan for 2014-2015, meaning the Service intends to publish something more authoritative than a news article in the coming months. We will reserve judgement until then. In the meantime, we will continue to advise our clients to get some proof of the hardship before authorizing a withdrawal. It would never occur to us that the employee’s word is a sufficiency.
This issue is a slightly different twist on what is known as “legislating from the podium.” At industry conferences, government officials will appear on panels and give their opinions on items in the law that may not be clear. It is less than desirable to have rules handed down in this fashion. Official written guidance (regulations, revenue procedures, notices, etc.) is better. When there is no official guidance, however, sometimes you have to go with the government officials’ opinions because there is nothing else to rely on. In the hardship situation, Fidelity is claiming that there has been previous “legislation from the podium” which is in conflict with this new “legislation from the news desk.”
Finally, let us not lose sight of the main point of the IRS article, which is entitled, “It’s Up to Plan Sponsors to Track Loans, Hardship Distributions.” This goes right along with what we wrote last month about recordkeeping requirements in general. We argued that records should be kept by the plan sponsor, and they should be kept essentially forever. What we learn from the IRS article is that before you can keep the records, you have to get them in the first place.