Hardship Proof

BenefitsLink Message Boards > Retirement Plans > Correction of Plan Defects
lindamichals
Sep 19 2008, 02:40 PM
An employer has asked this question. If upon a plan audit, it was determined there was
not sufficient proof attached to a hardship request, who is "liable"? The employee or
employer? What are the consequences of allowing a hardship without proper proof?
Also, I'm getting this question a lot. Participants are requesting hardships to prevent
eviction and/or foreclosure, however, no notice to evict or foreclose exists. The
participant simply wants to get "caught up" on their bills otherwise they will receive such
notice. Would the unpaid bills be sufficient proof?
Thank you.
Linda Michals
Sieve
Sep 19 2008, 02:56 PM
Be VERY careful with hardship distributions, because making distributions to someone
under age 59-1/2 from elective deferral accounts without meeting the hardship provisions
in the Plan is a potential disqualifying act. Require proof--e.g., court-ordered notice of
imminent eviction, medical bills, invoices for college tuition, etc. (if you are using safe
harbor hardhsip standards)--before making any hardship distribution. I see it as a
fiduciary issue (i.e., liability on ERISA administrator).
EPCRS allows for correction if hardship distributions are made when there are no plan
provisions allowing such distributions (EPCRS, App. B, 2.07(2)), but that does not
eliminate the need to meet the hardship distribution standards in the regs.: "This
paragraph [permitting correction by plan amendment] does not apply
unless . . . the plan as amended would have satisfied the qualification
requirements of 401(a) (including the requirements applicable to
hardship distributions under 401(k) . . .) had the amendment been
adopted when hardship distributions were first made available."
J Simmons
Sep 19 2008, 03:04 PM
Larry,
If the plan used the safe harbor definitions of hardship but paid out a hardship in a
situation not quite meeting any of those 6 defined categories, would VCP correction
include an amendment (retroactive) that relaxed at least that category to the point it picks
up the questionable situation?
The reason I ask is a few years back a TPA administering a grandfather, pre-1974 money
purchase pension plan with a 401k provisions assumed that in-service hardship
distributions were okay--in all 401k plans--and made the distribution. The plan, by its
terms, did not.

We VCP'd it, and our correction was to allow after-tax employee contributions (without
adjustment for investment earnings) to be the source of in-service hardship distributions
in this plan. There's an old Rev Rul that allows for such even in a money purchase
pension plan. We cited that as part of our VCP application and submitted a proposed
amendment along those lines. The IRS accepted that amendment as the fix in that
situation.
Just curious as to your thoughts and comments on whether you might be able to fix a lax
hardship situation by amending (retro) to the lesser standard.
Sieve
Sep 19 2008, 03:26 PM
John (don't know if I really ought to respond to someone who uses a fancy disclaimer . . .
) -As you described, the IRS--despite the limited situations in which amendments to a plan
are permitted under VCP--will often permit a correcting plan amendment which is very
narrowly drawn to cover the single whoops (how do you spell that, anyway?). So, I think
that they probably would accept a change from safe harbor hardship events to the more
general f & c to cover a good-faith bad distribution or 2. I really don't know what else
they could do, because I think disqualification is out of the question for that type of error.
If discovered on audit, like in the OP, I guess you'd have to use tear-stained cheeks to
covince the agent that you'll do better in future--I think that would work (even, maybe,
without the tear-stained cheeks, because there is little alternative for the Service). I just
can't see disqualification for a few of these. However, if the audit is expanded and it is
determiend that there are a whole slew of lax hardship distributions--i.e., all of them, and
there are a lot--such that it rises to the level of bad-faith determinations of hardhsip, then
I would expect the IRS to very seriously contemplate disqualifying the plan as failing the
exclusive benefit rule (or whatever that over-arching umbrella rule is called).
masteff
Sep 22 2008, 10:00 AM
QUOTE (lindamichals @ Sep 19 2008, 01:40 PM)
An employer has asked this question. If upon a plan audit, it was determined there was
not sufficient proof attached to a hardship request, who is "liable"? The employee or
employer? What are the consequences of allowing a hardship without proper proof?
Also, I'm getting this question alot. Participants are requesting hardships to prevent
eviction and/or foreclosure, however, no notice to evict or foreclose exists. The
participant simply wants to get "caught up" on their bills otherwise they will receive such
notice. Would the unpaid bills be sufficient proof?
Thank you.
Linda Michals

You might also re-examine what you're considering a "notice to evict/foreclose". They do
not have to be in actual eviction/foreclosure, just "imminent" threat of it. Most
landlords/lenders will provide a "you're past due, pay up or we may start the process to
evict/foreclose" letter, especially if it means they'll get paid all the faster.
See a prior post I made here: http://benefitslink.com/boards/index.php?s...st&p=163431
Sieve
Sep 22 2008, 10:51 AM
I don't see where "imminent" threat of foreclosure--if that's even the standard in the regs-is met by the bank threatening to commence a foreclosure action in its standard letter
when the employee is a month or 2 late. The reg cited in the referenced link doesn't say
you have to be in "immediate" threat of being foreclosed--it says that preventing a
foreclosure is automatically an "immediate and heavy" financial need. The word
"immediate" does not refer to foreclosure, and immediate and imminent are not the same.
If you want to be technical, making a payment on time certainly prevents the possibility
of a foreclosure, so under a loosened standard that would be a hardship, too. Hardship
distributions are serious business from the IRS perspective.
Don't leave it all up to the employer. The advisor needs to set parameters within which
the employer can make a call. Don't let the employer make hardships too easy. You'll
have lots of 'splainin' to do when the IRS audits.
J Simmons
Sep 22 2008, 10:59 AM
Isn't the language in the safe harbor categories "necessary to prevent" foreclosure?
In my state, the home buyer has 120 days after foreclosure proceedings are formally
begun and noticed up in order to prevent foreclosure sale to a third party.
Maybe a 10-day demand letter from an attorney that foreclosure proceedings will be
started if the entire past due amounts are not brought current before then would do.
masteff
Sep 22 2008, 11:52 AM
"necessary to prevent" is the real issue as John notes. The full discussion of that other
thread I linked discusses to what extent the risk of eviction/foreclosure must be current
(ie imminent) for it to be a valid hardship reason (i.e., excess other bills making it
difficult for the participant to pay their mortgage and therefore "maybe" becoming past
due is insufficient to "prevent" a foreclosure; the actual threat of foreclosure must be
imminent for it to be preventable, IMO).
The reality is how do you apply the regs in the real world as an administrator; remember,
the goal is sufficient documentation for the file to prove an eviction or foreclosure was
being prevented. We relied upon letters such as those I noted above. We never required
that actual eviction/foreclosure proceedings have been actually commenced before
allowing the hardship. Remember that the right to evict/foreclose is a standard part of
nearly every competent least/mortgage and simple reminder from the creditor of that

should be sufficient to put the participant on notice. Not that it proves I'm 100% correct,
but we did have full IRS and DOL audits during my time and while they questioned other
items on hardships, they never took issue w/ our eviction/foreclosure documentation.
Sieve
Sep 22 2008, 12:25 PM
You're absolutely right that process is critical. You're making a judgment call that making
a single timely monthly payment doesn't make a harship distribution "necessary to
prevent" foreclosure, but if I then get a letter from my bank 15 days later threatening
foreclosure then maybe that payment is, in fact, "necessary to prevent". Or if you draw
your line only when a notice is received after the 2nd missed payment--or some other
time--then that makes it an appropriate hardship distribution. I just happen to draw my
line a little more conservatively--and that's fine, since the real issue is that there is a
reasonable interpretation of the regs, performance of due diligence, consistency, use of
reasonably objective standards, etc. Guidance is a bit sparse, and we do what we can in
those circumstances.
But, for my part, rightly or wrongly, I wouldn't accept a letter that says "pay or we
can/will commence foreclosure proceedings" any more than I'd accept a letter from a
doctor saying "your condition requires surgery which will cost $15,000" when somone
claims a medical expense hardship ("Expenses for (or necessary to obtain) medical
care . . .").
J Simmons
Sep 22 2008, 01:32 PM
I agree with Larry. The letter from the mortgage company needs to be more concrete than
may/can foreclose. It needs to specify something like, "if you do not pay $X by Y date,
then steps toward foreclosing will be taken." In my view, only when the mortgage
company's threats get that 'connected' is the financial hardship 'necessary to prevent'
foreclosure. That's where I've drawn the line in the sand.
masteff
Sep 22 2008, 01:32 PM
QUOTE (Sieve @ Sep 22 2008, 11:25 AM)
and that's fine
We'll agree there are different levels which a plan might require before accepting an
eviction/foreclosure hardship. I'm apparently from the less conservative school.
So back to the orginal post...
QUOTE (lindamichals @ Sep 19 2008, 01:40 PM)
What are the consequences of allowing a hardship without proper proof?
The plan has a burden to have some form of documentation on file to prove you complied
w/ your own plan document which says w/drwls are only allowed for X, Y and Z reasons.
The consensus is some form of notice from the creditor regarding either potential or
actual eviction/foreclosure proceedings.

QUOTE (lindamichals @ Sep 19 2008, 01:40 PM)

The participant simply wants to get "caught up" on their bills otherwise they will receive
such notice. Would the unpaid bills be sufficient proof?
The consensus is that no, other unpaid bills that "might" cause the participant to become
past due on their rent/mortgage are insufficient. The fact that someone owes $500 on their
QVC credit account does not prove they will be subject to eviction/foreclosure on an
unrelated lease/mortgage.
My most common saying to participants in this situation is: "The IRS has a much stricter
definition of 'hardship' than you and I do. The IRS's definition is very narrow and the plan
is limited to only what the IRS and Congress provided as hardship reasons." People have
a psychological barrier to letting their mortgage go past due when they'll willingly let
multiple credit cards slide w/ exorbitant late fees; people can be counterproductive until
you can get them to understand the circumstances in which the plan can help them.
Sieve
Sep 23 2008, 12:06 AM
masteff -Thanks for bringing us back to the OP and your good summary for Linda.
I would just add that the administrator must apply standards that are consistent and that
demonstrate a good-faith attempt to meet the requirements of the regs. If the
administrator's standards for determining hardship are so lax that appropriate and relevant
documentation is totally lacking, then these distributions might well be in violation of
plan terms and IRS regs, and, ultimately, could result in plan disqualification. As
conservative as I am in my approach to hardship distributions, I concede that
disqualification is an extremely limited possibility--but you do need to convince the
employer to take those standards seriously.
K2retire
Sep 23 2008, 06:19 PM
Am I hallucinating that there used to be something that said the plan administrator was
entitled to rely on a written representation by the employee as to the hardship without
requiring any proof unless the employer had actual knowledge to the contrary?
J Simmons
Sep 23 2008, 06:34 PM
Not hallucinating. An ER can rely on the EE's representations, if nothing known to the
contrary, to establish that there are no other available resources to satisfy the immediate
and heavy financial need. Treas Reg 1.401(k)-1(d)(3)(iv).
Sieve
Sep 24 2008, 09:33 AM
And, the six safe harbor hardships are "deemed " to be demonstration that there is an
immediate and heavy financial need, but the regs don't allow the administrator to rely on

the employee's statement that there is such a hardship. (Treas. Reg. Section 1.401(k)-1(d)
(3)(iii).) So, some prooof of the existence of the hardship is still required. As John
indicates, the reliance on an employee representation which the regs permits goes to
whether other means are available to meet that need--not as to whether a hardship exists.