DC loans and hardship requests can be problematic for administrators at companies that sponsor a defined contribution (DC) plan like a 401k or 403b but they are a fact of life. Beyond the troubling fact that they eat into retirement savings and can have a negative effect on retirement readiness, plan sponsors have to know the rules on how to stay in compliance or risk fines and penalties.
At a TPSU program held at Notre Dame, Craig Draper, in-house counsel at Adjunct Lecturer Lakeside Wealth Management Group based in Chesterton Indiana, explains a few steps plan sponsors should take in administering loans and hardship withdrawals.
According to the IRS, safe harbor hardships withdrawals must be:
- Due to an immediate and heavy financial need.
- Limited to the amount necessary to satisfy that financial need.
The IRS also defines the financial needs which include:
- Medical care expenses for the employee, the employee’s spouse, dependents or beneficiary.
- Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments).
- Tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents or beneficiary.
- Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.
- Funeral expenses for the employee, the employee’s spouse, children, dependents, or b
- Certain expenses to repair damage to the employee’s principal residence.
Participants may not contribute for six months after a hardship withdrawal.
Draper explains that although plan sponsors have more flexibility for loans, they must administer them uniformly for all participants. They must also have documentation for both hardship withdrawal’s and loans to verify the reasons for the withdrawals.
Plan sponsors should turn to their advisor, if they are a DC plan specialist who understands the rules, their counsel or their TPA for help – the record keeper can assist with documentation and verification.
TPSU has developed best practice loan policies which includes:
- One loan at a time
- Six month waiting period between loans
- Loans based only on hardship which are verified and administered by the plan’s record keeper
- Default insurance for those involuntarily separated which is why most loans default
