Sunday, October 22, 2017

Is the IRS Status of your Defined Benefit plan in Jeopardy?

Posted by OnCourse Staff July 8, 2016 2:17pm

Photo Credit: lightwise

By James Redding, Senior Manager, Financial Audit

Electronic certification (“e-certification”) for loans and hardship withdrawals, without the retention of appropriate supporting documentation, is considered a QUALIFICATION FAILURE. The Code requires tax-exempt organizations to comply with Federal tax law to maintain its tax-exempt status.  In a recent IRS newsletter related to e-certification, we noted that the IRS indicated that it is not sufficient for plan participants to keep their own records for hardship and loan distributions because “Participants may leave employment or fail to keep copies of hardship documentation, making their records inaccessible in an IRS audit.”

Many plan administrators rely exclusively on e-certification to manage hardship and loan distributions for their retirement plans. Typically, a participant will self-certify that he or she meets the criteria to receive a hardship distribution. For example, the participant may self-certify that a hardship distribution is necessary to pay off steep medical expenses or an imminent foreclosure. In the past, the IRS guidance on what is necessary to support a hardship was unclear, and many practitioners and Third-Party Administrators (“TPA”) have felt that self-certification was sufficient.   

The IRS has issued guidance stating that electronic self-certification is not sufficient documentation of the nature of a participant’s hardship. Some TPAs allow participants to electronically self-certify that they satisfy the criteria to receive a hardship distribution. While self-certification is permitted to show that a distribution was the sole way to alleviate a hardship, it is not deemed adequate  to show the nature of a hardship [See Treasury Regulation Sections 1.401(k)-1(d)(3)(iv)(C) and (D)]. Even if the plan uses a TPA to handle participant transactions, the Plan is ultimately responsible for the proper administration, including record retention. Plan sponsors must request and retain additional documentation to show the nature of the hardship. Not retaining records for hardship and loan distributions, and not making them available for examination, is a QUALIFICATION FAILURE that should be corrected using the Employee Plan Compliance Resolution System (“EPCRS”).

In order to comply with the IRS guidance for record retention related to hardship withdrawals, the plan sponsor should obtain and retain the following:

  1. Documentation of the hardship request, review, and approval
  2. Financial information and documentation that substantiates the employee’s immediate and heavy financial need
  3. Documentation to support that the hardship distribution was properly made in accordance with the applicable plan provisions and the Internal Revenue Code
  4. Proof of the actual distribution made and related Forms 1099-R

A retirement plan may (but is not required to) allow participants to receive hardship distributions.  A hardship distribution from a participant’s elective deferral account can only be made if the distribution is due to an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need.

Under a “safe harbor” in IRS regulations, an employee is automatically considered to have an immediate and heavy financial need if the distribution is for one of the following:

  • 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 beneficiary
  • Certain expenses to repair damage to the employee’s principal residence

The amount of a hardship distribution must be limited to the amount necessary to satisfy the need. This rule is satisfied if:

  • The distribution is limited to the amount required to cover the immediate and heavy financial need.
  • The employee could not reasonably obtain the funds from another source.

Unless the employer has actual knowledge to the contrary, the employer may rely on the employee’s written statement that the need cannot be relieved from other available resources, including:

  • Insurance or other reimbursement
  • Liquidation of the employee’s assets
  • The employee’s pay, by discontinuing elective deferrals and after-tax employee contributions
  • Plan loans or reasonable commercial loans

Hardship withdrawals are subject to income taxes and a 10% additional tax on early distributions. Employees who take hardship distributions cannot repay it to the plan.

Even though the newsletter constitutes informal guidance and does not have the effect of a regulation or IRS Notice, the newsletter is particularly troubling because it clearly shows how the IRS will act when auditing qualified plans. Under this guidance, plan sponsors will have to take much more of a hands-on role when it comes to hardship distributions. 

This new guidance contravenes the IRS’s published FAQs on hardship distributions, which can be found at http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Hardship-Distributions . In Question 3, the IRS specifically provides that, to the extent that it has no actual knowledge to the contrary, “an employer may generally rely on the employee's representation that he or she is experiencing an immediate and heavy financial need that cannot be relieved from other resources.”

Many TPAs are also e-certifying plan loans and failing to obtain and retain sufficient documentation for each plan loan granted to participants. It is indicated above that it is the plan sponsor that is ultimately responsible to obtain and retain supporting documentation for withdrawals.  A plan sponsor should retain the following for each plan loan granted to a participant:

  1. Evidence of the loan application, review and approval process
  2. An executed plan loan note
  3. If applicable, documentation verifying that the loan proceeds were used to purchase or construct a primary residence
  4. Evidence of loan repayments
  5. Evidence of collection activities associated with loans in default and the related Forms 1099-R, if applicable

Note that if a participant requests a loan with a repayment period in excess of five years for the purpose of purchasing or constructing a primary residence, the plan sponsor must obtain documentation of the home purchase before the loan is approved. IRS audits have found that some plan administrators have impermissibly allowed participants to self-certify their eligibility for these loans.

If you are using a TPA to e-certify hardships and loans, it’s time to examine your process and determine if you are, in fact, obtaining and retaining the necessary supporting documentation to assure that a qualification failure does not occur.  

 

Comments

Add a comment

  • Required fields are marked with *.

If you have trouble reading the code, click on the code itself to generate a new random code.



 Image

OnCourse Staff

The OnCourse writing staff work to keep you informed about the most pertinent financial industry news of the moment



OnCourse Staff's Posts Subscribe to RSS Feed



Training – An Investment and Risk Management Tool
Are You Gambling with Your BSA Program?
Same Day ACH Credits – Phase One
Is the IRS Status of your Defined Benefit plan in Jeopardy?
Is your Institution Monitoring Working Capital Lines of Credit?
Financial Reporting and Regulatory Update on the Horizon
Planning in a Consolidating Banking Industry
To opt-out or not to opt-out, that is the question – A reminder on March 31, 2015 Call Report, Schedule RC-R, item 3.a
Cybercriminals Broaden their Attacks in Social Networks
The Importance of Segregating a Bank’s Credit Function from its Lending Function
Requesting Current Financial Information
Countdown to Windows XP End of Life and Support: Are you still at Risk?
314(b) Distinct Advantages for Financial Institutions
Where is the Document?
Do You Know The Security Features of the New $100 Bill?
Segregation of Duties for Wire Transfer Processing
Community Banks Slowly Warm Up to Private Student Loans
Has your Bank updated the Adverse Action Notice?
How Does Your Bank Handle Customer Requested Maintenance Changes?
OCC Releases Booklet on "Common Sense" Community Banking
New SAR Filing Updates
The Importance of BSA Training
FFIEC Proposed Risk Management Guidance on Social Media: Beware and Prepare
Pandemic Preparedness: Are you testing your Pandemic Plan?
FFIEC issues revised “Supervision of Technology Service Providers” booklet
Is Your Institution's Marketing UDAAP Compliant?
Electronic Work Papers - Why P&G Made the Switch
Community Lenders Seize Market Share From Big Banks by Using Advanced Online Lending Technology
New FinCEN Guidance for CTR Aggregation for Businesses with Common Ownership (FIN – 2012 –G001)
Curry: Operational Risk Now OCC’s Top Concern
JOBS Act Client Alert - Rules 506 of Regulation D
Wall Street Receives Volcker Rule Clarity
De-stressing with stress testing
Banks Participate in Information Sharing to Battle Online Theft
IT security: Is your program still effective?
Mobile banking: How do we get there?
UBS further struggles with $2 Billion loss by Rogue Trader
Capital One Becomes Dodd-Frank Test as Nation’s Fifth Largest Bank
Community Banks to receive US Funding for Small Businesses
FDIC fields questions about overdraft guidance
Negligent Hiring – A mistake can cost more than just money!
From Embezzlement to Imprisonment: Former Citigroup employee faces charges with $19.2 million in bank fraud
Finding the Right Hire
Model behavior: Is your ALM model capturing your bank’s risks?
ALLL best practices: Pay attention to qualitative factors
Abandoned Property Law, and its new New York State of Mind
FDIC releases Provisions on Dodd-Frank to help Community Banks
Social Media in the Employment Arena – It Gets Funky!
Banks and Businesses get "swiped" over Fees
A little bit of this, and a little bit of that: Fed Unveils list of Banks Helped during Financial Crisis of 2008
To Test or Not to Test; That is the Question
2011 Failed Bank List Hits 25
Committee on Financial Services to Hold Hearing on the Effects of Dodd-Frank on Small Biz and Banks Today
2011 Failed Bank List up to 18
The Test Drive: Leasing or Buying a HR IT Platform
Double Digits: Bank Closings up to 11 in 2011
FCIC Releases Report on the Causes of the Financial Crisis
Another One Bites the Dust: Regulators Close 4 Banks
On Notice: FDIC Issues Rule for Temp Unlimited Deposit Insurance
2011 Failed Bank List Up to 3
Stick 'Em Up!
Time for a Tune-Up: The Necessity of a HR Audit
Visa Instituting Two-Tiered Debit Card Interchange Structure
The First Failed Banks of 2011
The Law on Your Side: Understanding HR Regulations in 2011
No Respite from RESPA