It’s become easier for plan participants to take distributions from their defined contribution (DC) retirement plan account balances, but plan sponsors still have a fiduciary duty to ensure that the need for these distributions is real.

In the November/December issue of Benefits Magazine, attorney Martha Mohs provides an update on the laws and regulations affecting hardship distributions and offers guidelines for plan sponsors that want to maintain a substantiation policy. Mohs is an attorney at Reinhart Boerner Van Deuren s.c. in Milwaukee, Wisconsin.

What Are Hardship Distributions?

Hardship distributions are an in-service distribution option that allow participants to request their employee and employer contributions to a DC retirement plan including earnings, in the event of a financial hardship without a distributable event such as death, disability or retirement. The hardship distribution must be made on account of an “immediate and heavy financial need,” and the amount requested must be limited to the amount necessary to satisfy the financial need.

According to the International Foundation’s 2024 Employee Benefits Survey, 76% of respondents allow hardship distributions from their 401(k) plans and nearly 12% allow them from 403(b) plans.

What Are the Substantiation Requirements Under Federal Law and Guidance?

Since 2017, recent legislation, including the Tax Cuts and Jobs Act and the SECURE 2.0 Act of 2022, states that “plan sponsors are permitted to rely on a participant’s self-certification of the existence and amount of the participant’s underlying financial need necessitating a hardship distribution unless the plan sponsor has actual knowledge to the contrary,” Mohs wrote.

Why Might a Plan Want to Have a Substantiation Policy?

Plan sponsors have been hesitant to transition to self-certify for hardship distributions for a couple of reasons, Mohs noted.

• If it becomes easy to make requests, members might treat their retirement savings accounts as savings accounts, jeopardizing their retirement security and creating an administrative burden for the plan.
• Because of the fiduciary duty to investigate if the plan is aware that a hardship may not exist, plan sponsors are put in the difficult position of determining whether and how to investigate distributions when questions arise.

“Without such a policy, it can be difficult for plan administrators to determine how much investigation to perform when reviewing any individual hardship distribution. Scrutinizing some applications while easily approving others could lead to claims of discrimination against a plan. However, reviewing hardship distribution applications without a critical eye could lead to plan leakage. A hardship distribution substantiation policy could help plan administrators strike an important balance,” Mohs wrote.

What Should a Hardship Distribution Policy Include?

Mohs recommended that plan sponsors consider the following when preparing a policy.

• What specific expenses will be eligible for hardship circumstances? For example, if a plan allows hardship distributions for the purchase of a principal residence, the policy should be clear about whether expenses incurred related to inspections, appraisal, title transfers or other fees connected to the purchase may be included.
• What documentation will be required? The policy should be clear regarding whether the plan sponsor requires original documents or will accept copies, whether invoices must be itemized, and whether documentation can be submitted by the participant or must be submitted by the specific vendor.
• Should requests be made within a specific time period? For example, Mohs explained that if the participant experienced a casualty loss impacted by a federal disaster, the plan may want to wait to see what, if any, insurance payments they will receive before requesting a distribution. However, if too much time passes, it can become difficult to determine whether the damage is actually related to a casualty event.

How Will the Plan Handle Outside-the-Box Requests?

Plan sponsors are certain to encounter requests that don’t cleanly satisfy the hardship distribution circumstances, Mohs cautioned. Unusual real-life examples of hardship distribution requests include participants seeking to buy recreational vehicles to use as a residence or to purchase shipping containers to build a “tiny home.”

In such cases, Mohs recommended that plan sponsors review the request against the language of the plan document and the plan’s procedure to make reasonable determination of eligibility. Plan sponsors should also consider what documentation to request and make sure it is consistent with the documents for hardship distribution requests of the same nature.

Conclusion

Adopting a hardship distribution policy may help plans balance the desire to avoid creating unnecessary burdens on plan members who are experiencing financial difficulties with the plan’s desire to minimize fiduciary risks and plan leakage, Mohs wrote. Plans should decide whether they are in a good position to offer hardship distributions and plan for what this allowance would entail.