By Carla Grant and
Christopher Veldman
Jan. 20, 2011
Companies have an important responsibility when administrating their 401(k) plans as the failure to enforce proper administration can lead to administrative hassles, penalties and even plan disqualification. Two common problem areas for many companies include errors with hardship distributions and delinquent participant contributions.
With the dismal economy of the last few years, hardship distributions have unfortunately become more popular than ever. This rise in hardship distributions has also brought on a rise in the frequency of mistakes made when processing these requests. When non-compliance arises, the company can be subject to administrative hassles and even the disqualification of the 401(k) plan. Therefore it is extremely important to understand the very specific and unique rules associated with hardship distributions.
While the hardship distribution provision is common in 401(k) plans, it is not an automatic feature and unless your plan specifically provides for this feature, participants are not allowed to take this distribution. If your plan allows it, then the plan document must provide guidance as to when participants are allowed to take the distribution.
Generally, participants are required to exhaust all other resources before they can claim a hardship. These resources include all other in-service withdrawals from the plan, including loans for which the participant is eligible.
Once it is determined the participant has exhausted all other resources, he or she must prove their financial need meets the criteria of an eligible financial hardship as described by the plan. These generally include health expenses, prevention of eviction, purchase of primary residence, and tuition expenses. This proof of financial hardship should be maintained by the plan administrator for inspection by the Department of Labor (DOL) should they decide to conduct an audit.
Most plans require a six-month suspension of payroll deferrals after a hardship is taken, and errors often occur when the employer fails to suspend deferrals. In these cases, a potential remedy is to begin the suspension when the error is discovered and refund deferrals to the participant from their account. The responsibility to reinstate deferrals after the six-month suspension can be either the employee’s or the employer’s – the key is to be consistent and follow requirements of the plan document.