Understanding hardship self-certification

Q&A with Mike Hadley, partner at Davis & Harman, LLP

Hardship distributions tend to be one of the most time-intensive and difficult parts of plan administration. To help, the IRS issued guidelines for its auditors that provide a more streamlined path for plans to substantiate hardship through participant self-certification of financial need. Workplace Insights talked with Mike Hadley about what plan sponsors should know about this new approach.

Mike Hadley
Mike Hadley

Workplace Insights (WI): Many 401(k) plans offer hardship distributions, and participants who apply have to provide documents to prove that they meet the requirements—what has changed?

Mike Hadley (MH): To show eligibility for a safe harbor hardship distribution, participants have to justify that they have an immediate and heavy financial need. Traditionally, they justify the need by providing supporting documentation depending on the type of hardship (i.e. medical, tuition and mortgage bills, among other things). The guidance issued by the IRS in 2017 states plans no longer have to collect paperwork to substantiate a hardship, and instead can rely on a particular process whereby a participant self-certifies their hardship. Importantly, the new procedures are not simply a “check the box” for the participant; the participant must provide specific information from the source documents which they agree to retain, in the event of an audit.

WI: Some plan sponsors are concerned that allowing a participant to self-certify could create a risk of audit or impact their fiduciary responsibilities. What would you say to these plan sponsors?

MH: I can appreciate that plan sponsors are concerned about an audit, but is important to keep in mind that the hardship self-certification guidance provided by the IRS was originated by the IRS to help ease the processes of IRS field auditors. The guidance directs IRS auditors to ask for source documents only if the information provided by the employee was “incomplete or inconsistent on its face,” or if there were more than two hardship distributions in a year, and then only if there is no adequate explanation and only with the manager approval. In any event, the guidance does not require the plan to guarantee that the source documents exist or direct the agent to disqualify the plan if an employee cannot produce the documents.

WI: What are the benefits of self-certification versus the process by which a plan sponsor collects the documents and substantiates?

MH: The existing process of collecting personal documents from participants can be slower, manually intensive, invasive and expensive. In addition, the plan sponsor is then responsible for the protection and privacy of those documents. A self-certification process eliminates the necessity for the plan sponsors to have to retain documents in the event the plan is audited, and is more streamlined and quicker for the participant.

WI: Can any 401(k) plan implement self-certification procedure?

MH: Because of the guardrails the IRS included in the guidance, the self-certification process is best used in a plan that allows no more than two hardship distributions in a year. If a plan allows for more than two hardship distributions in a year, the employer may want to consider carefully if self-certification is right for the plan. In addition, the IRS guidance applies only to distributions that are deemed to be on account of an immediate and heavy financial need, i.e. safe harbor hardship events. For distributions that are not made under the safe harbor hardship events, I recommend that the plan consult its counsel.

To learn more about the IRS guidance, please download the white paper authored by Mike Hadley, Using IRS self-certification rules to streamline hardship distribution administration.

Davis & Harman, LLP is a regular contributor for Bank of America, focusing on legislative and regulatory matters affecting employee benefit plans. The opinions expressed are Davis & Harman’s and do not necessarily reflect the opinions of Bank of America.