Studies by both Bank of America and Fidelity showed a disturbing trend last year: Hardship withdrawals and participant loans from retirement plans increased, likely due to inflation and the rising cost of living. Bank of America’s 2023 Participant Pulse found the number of participants taking hardship distributions increased by more than a third year-over-year, following increases in Q1 2023. Further, the report showed more participants borrowing from their workplace plan in Q2 (2.5%, an increase from 1.9% in Q1 2023). The good news is that both B of A and Fidelity’s research found most employees were maintaining – and even increasing — their contribution levels, a sign that a well-funded retirement is still a priority for many plan participants.

With the increase in hardship distributions and participant loans, plan sponsors need to understand their responsibilities for overseeing and tracking these activities. Even if you rely on a third-party administrator or delegate administrative duties, plan sponsors are ultimately responsible for meeting the IRS’s guidelines for reporting these activities.

Plan sponsors whose plans allow for hardship distributions and loans should adopt a proactive approach to tracking, even when administrative duties are delegated. Here’s what you need to know:

For hardship distributions:

  • Under SECURE 2.0, employers can now create their own policies and procedures to allow participants to self-certify that they are taking their hardship distribution because of an immediate and heavy financial need. Employers do not need to collect documentation when approving distributions.
  • Plan sponsors do, however, need to keep and maintain hardship distribution records, either in paper or electronic format, using the Summary Substantiation method for safe-harbor hardship distributions. Records needed include:
    • Documentation of the hardship request, along with the employer’s review and approval.
    • Information that substantiates the employee’s immediate and heavy financial need.
    • Proof that the hardship distribution followed applicable plan provisions and the IRS Code.
    • Documentation to prove that the distribution occurred, along with Form 1099-R.

For loans:

Plan sponsors should keep the following records in either paper or electronic format for each loan granted to a plan participant:

  • Evidence of the loan application, review, and approval process.
  • An executed plan loan note.
  • Documentation verifying the employee used the loan proceeds to purchase or build a primary residence (if applicable).
  • Proof of loan repayments.
  • For defaulted loans, evidence of any collection activities and related Form 1099-R, if applicable.
  • If the loan repayment period is more than five years, during which the employee plans to purchase or build a primary residence, the plan sponsor must receive purchase documentation before approving the loan.

Before approving any hardship distributions or loans, be sure to review your plan’s rules to understand how the plan defines a hardship, what the employee must do to be in compliance, and what limits exist on the amount and types of funds an employee can receive from their retirement account. While SECURE 2.0 now enables employers to allow self-certification from employees, your plan may still require a statement or verification of the employee’s hardship.

As you audit your plan’s hardship distributions, you may find situations where mistakes occurred and hardship distributions went to employees improperly. If so, don’t panic. The IRS offers a “Fix-It Guide” to help you resolve problems and make corrections.

While the Federal Reserve predicts falling inflation this year, it’s also likely that high prices will continue in 2024, potentially prompting more consumers to seek relief through hardship withdrawals and loans. Understanding your plan’s rules and ensuring proper tracking can help you avoid headaches later, while still helping to fulfill your employees’ needs.

At Savant Wealth Management, our goal is to deliver the expertise and experience to help provide valuable guidance as you design and implement a company-sponsored retirement plan that is right for your business. Our team can help relieve you of a significant part of the fiduciary burden you carry as a plan sponsor, and we can also offer boots-on-the-ground assistance to help your plan remain compliant, your reporting stay current, and your 401(k) run smoothly, year after year

To learn more about our retirement plan service options, visit our website to read our recent article, “Choosing a Plan Provider: Some Key Questions.”

Savant Wealth Management (“Savant”) is an SEC registered investment adviser headquartered in Rockford, Illinois. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Savant. This is intended for informational purposes only.

Author Patricia L. Hutchinson Director of Retirement Plan Services

Patty has been involved in the financial services industry since 2006. She earned a bachelor of science degree in marketing and management from Northern State University in Aberdeen, SD, and an MBA from Colorado Technical University, Sioux Falls, SD.

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