Plan Sponsors Must Retain Hardship and Loan Documentation
Posted on July 9, 2015 by Legacy Retirement Solutions
In a recent Employee Plans Newsletter, the Internal Revenue Service (“IRS”) surprised many plan sponsors and practitioners when it described its position on certain document retention and certification obligations associated with participant loans and hardship distributions. This description was surprising because the IRS emphasized the plan sponsors’ duties to retain formal documentation of these transactions. However, many plan sponsors rely exclusively on their “recordkeepers” and “third-party retirement plan administrators” to process such distributions which could often result in the failure of the plan sponsor to maintain the documentation necessary to satisfy the expectations of the IRS in this regard. The remainder of this article discusses the guidance and what it means for plan sponsors.
According to the guidance, the plan sponsor must retain the following documents, in either paper or electronic format, with regard to each hardship withdrawal:
- Documentation of the hardship request, review and approval;
- Financial information and documentation that substantiates the participant’s “immediate and heavy financial need”, as defined in the Treasury Regulations;
- 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.
One of the main problems associated with the satisfaction of these requirements is that, in practice, many plan sponsors and retirement plan service providers allow participants to electronically “self-certify” that they qualify for a hardship distribution. However, the guidance stresses that self-certification is never sufficient to demonstrate the nature of the participant’s hardship. More specifically, to qualify for a hardship withdrawal, a participant must prove that the withdrawal is “necessary” and that it will meet an “immediate and heavy” financial need. While self-certification is permitted to show that a distribution was necessary, it is not permitted to show that the need is immediate and heavy. Thus, the guidance instructs sponsors that they must independently obtain and retain documentation showing the nature of the hardship.
As an example, most recordkeepers offer “on-line” management and processing of the entire hardship withdrawal process. These electronic systems often require the participant to:
- Provide information about their particular financial need (whether the expenses are intended to prevent eviction or foreclosure, or to pay for medical costs, tuition and education expenses or funeral outlays);
- Certify that the information provided is accurate; and
- Retain back-up documentation as proof of financial need.
Under this example, the participant’s sole possession of “back-up documentation as proof of financial need” is insufficient. Instead, the plan sponsor should possess its own copies of documentation proving the financial need in order to avoid running afoul of the guidance. Such documentation might consist of insurance bills, escrow paperwork, funeral expenses, bank statements, etc.
In addition to the hardship withdrawal issues discussed above, the guidance discusses document retention and certification issues in connection with plan loans. In this regard, the guidance states that the plan sponsor must retain, in either paper or electronic format, the following documents with respect to each participant loan from the plan:
- Evidence of the loan application, review and approval process;
- An executed plan loan note;
- If applicable, documentation 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.
With regard to loan certification, the IRS was particularly concerned about the proper handling of the exception to the general 5-year loan term requirement that applies to the purchase or construction of a primary residence. In that case, the IRS emphasized that a plan sponsor must obtain documentation of the home purchase or construction before a loan is approved for greater than the generally appropriate 5 year term.
With regard to both the hardship withdrawal and loan issues described above, the IRS indicated that it had detected failures of such requirements in the context of its performance of retirement plan audits. It also indicated that such failures constitute tax-qualification defects that should be voluntarily corrected under the provisions of the Employee Plans Compliance Resolution System (“EPCRS”).
Presumably the context of this discussion by the IRS indicates an interest in ensuring plan sponsor compliance with these requirements and suggests that the IRS will focus on these issues during future enforcement actions. Therefore, in order to remain compliant, it is important that plan sponsors understand and satisfy the obligations discussed by the IRS within this recent guidance.
If you would like to read the IRS Employee Plans Newsletter article referred to within this article, it is available on the IRS website at: http://www.irs.gov/Retirement-Plans/Its-Up-to-Plan-Sponsors-to-Track-Loans-Hardship-Distributions.
We sincerely hope that this article helped you to better understand this topic. However, under no circumstances is it to be construed as financial, tax or legal advice. Therefore, if you believe that it may apply to your (or your client’s) company, be sure to further discuss it with a qualified retirement plan professional. For more information about this topic, please contact our marketing department at 484-483-1044 or your administrator at Legacy.