FIS Relius
Substantiation Guidelines for Hardship Distributions 4/10/2017
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By S. Derrin Watson, Esq.

(Note: The following is a guest column from S. Derrin Watson, Esq.  Mr. Watson will be speaking at the upcoming Pensions on Peachtree.)

The IRS has released audit guidelines which provide a roadmap for employers to demonstrate that they are properly handling hardship distributions. It’s about time!

I remember vividly my disappointment on this score when the Treasury issued the 401(k) regulations in 2004.  I know those rules would be vital to my teaching and read them avidly when they were issued. 

I didn’t want to break my reading for lunch and brought my laptop with me to a nearby restaurant. (Yes, I am a pension geek.  Why do you ask?) I filled my plate at the salad bar and sat down to continue my studies.  My fork was on route to my mouth when I read these words. “Some commentators asked for specific guidance on the documentation and verification requirements for a hardship distribution.” Instantly, I sat up and dropped my fork to the plate.  “Yes!” I cheered. I recalled how often I had been asked that question in seminars, only to respond that we had no clear guidance. “Finally,” I thought, “we will have an answer.”

Imagine my disappointment when the next sentence read simply, “The final regulations do not address this issue.” Worse, the Treasury was not content to dash my hopes along with my fork; it had to rub salt in the wound. “However, taxpayers are reminded that section 6001 requires that they keep the records necessary to demonstrate compliance with the qualification requirements of section 401 and the rules of section 401(k) and 401(m).”  In other words, “We won’t tell you what records you need to keep, but you’d better make sure you keep them if we audit you!”

In the following 13 years, I have repeatedly told practitioners that they should advise employers to obtain and retain documents showing the purpose and the amount of hardship distributions.  The IRS confirmed that this was necessary in “soft guidance” on its web site issued roughly two years ago. The service urged employers to keep “Financial information and documentation that substantiates the employee’s immediate and heavy financial need.”  They added that participants could not self-certify hardships and warned, “It’s insufficient for plan participants to keep their own records of hardship distributions. Participants may leave employment or fail to keep copies of hardship documentation, making their records inaccessible during an IRS audit of the plan.”

That’s still good advice, but it is often impractical in the 21st century. Particularly with plans handled by large recordkeepers, efficient administration demands that call centers and web forms have the flexibility to initiate hardship distributions, without the burden of requesting and storing casualty repair estimates, tuition bills, and escrow statements.

The IRS recently issued audit guidelines which provided two alternative approaches plans could use to document hardship distributions under audit. The first method is the old standby: retain source documents which “substantiate the hardship distribution.” That means the documents should show the amount of the hardship and its purpose.  If a hardship is for the medical, educational, or funeral expenses of a family member, dependent, or beneficiary, the documents should show the identity of that person to prove that the distribution is permitted. 

If the audit guidelines had stopped there, they would not have warranted much attention.  Fortunately, they go on to provide a second method to prove hardship needs: the plan obtains and produces to the auditor a “summary” of information contained in the source documents. 

The beauty of the summary approach is that it works well for a call center or web form.  I can envision the phone call:

Participant: I’m Amy Smith and I want a hardship distribution for my son’s college expenses.

Call Center: I can help you with that.  What’s your son’s name?

Participant: Chris Smith.

Call Center: Great.  What’s the name and address of the school?

The call center takes down the answers and the plan makes them available to the IRS on audit.  But for this to be sufficient, the plan must do four things:

1.    The plan must provide specified disclosures to the participant.

2.    The plan must require the participant to retain the source documents and agree to produce them on request.

3.    The summary must answer specific questions the IRS listed.

4.    If the summary is obtained by a third party other than the employer, the third party must provide “a report or other access to data to the employer, at least annually, describing the hardship distributions made during the plan year.”

If the plan fails any of these steps, then the auditor can ask for the source documents. Additionally, if a participant receives more than two hardship distributions in a year “in the absence of adequate explanation,” the auditor can ask for the original source documents. Follow-up medical expenses or quarterly tuition payments are examples of “adequate explanation.”

The audit guidelines include an attachment listing the required disclosures and the information which must appear on the summary. The guidelines apply to 401(k) and 403(b) plans and are limited to the “safe harbor” hardship distribution needs.

Ilene Ferenczy and I will address the new hardship rules in our Keeping Current presentation at Pensions on Peachtree.  Additionally, I am preparing a sample form plans can use to provide the disclosures and request the summary information, and we will make that form available to conference attendees.


Pensions on Peachtree (POP) – Atlanta, GA – April 24-25

Seats are still available, register online.

Faculty: Alison Cohen, Ilene Ferenczy, Robert Richter, David Schultz, and Derrin Watson. View the full program Agenda.

Earn up to 15 CE credit hours (based on 50 min. per hour), including 2 Ethics hours.

Fundamentals of 401(k) and Other Qualified Plans – June – registration open

Register online today to get the early bird discount!

Earn up to 21.5 CE credits for this 3-day seminar. View program details, agenda.

Presented in four cities only in 2017:

Charlotte – June 5-7

Pittsburgh – June 12-14

Chicago – June 19-21

Irvine, CA – June 26-28

More 2017 Live Seminars – Just announced

We are currently working on the following live workshops for 2017:

*Presented back-to-back in July/August:

Form 5500 Workshop

ERISA Workshop (covering Current Events, EPCRS and VCP, and Plan Amendments)

*Presented back-to-back in September/October:

403(b) Plans for 401(k) Administrators

403(b) Prototype Document Workshop (2-day program)

Dates and locations will be limited for each program. Final dates/locations, program details, and online registration will be posted here, one series at a time, starting around May:

Live Web Seminars
General Nondiscrimination Testing for DC Plans (401(a)(4)), 4/18, 12:00 PM ET

Compensation: Distinctions with a Difference, 4/27, 12:00 PM ET

Highly Compensated Employees: Who are These People, 5/4, 12:00 PM ET

403(b) Plans for 401(k) Administrators: A 3-part program, 5/9, 12:00 PM ET

For more details about these programs, and to register online:

Save the Date:

Chicago Advanced Pension Conference – September 6-8

Just for ERPAs Workshop, Chicago, IL – September 5

Westin Michigan Avenue Hotel. Event details and online registration will be available in June, here.