401(k) Hardship Withdrawals Increase with Employee Economic Woes

Because we know that many people are feeling the financial stress that comes with this economic downturn, it's not surprising to read in a recent report from Mercer that the percentage of 401(k) plan participants who took a hardship withdrawal out of their account increased 21 percent for the first 6 months of 2008 compared with the same period in 2007. But given this figure employers should be thinking about these figures and anticipating such requests within their own companies.

The IRS allows hardship withdrawals, but this does not mean that employers should automatically grant every request. It's crucial that employers understand the conditions set by the IRS for withdrawals, and that you check with your 401(k) plan to understand their policies toward withdrawals.

The IRS says that hardship withdrawals can be taken from 401(k) plans for “immediate and heavy financial need.” IRS examples of this need include:

• Extraordinary medical expenses for an employee or their dependents.
• Expenses related to the purchase of a home, but not mortgage payments.
• Expenses for up to a year of post-secondary education.
• Expenses to prevent eviction or foreclosure.

Even with the IRS guidelines, plans don’t have to allow these withdrawals. As an employer, you should check your plan document to see if they are included as an option before an employee comes to request one.  If your plan does not allow them, you can’t make an exception or a quick amendment to your plan.  All 401(k) plan amendments follow a specific once-a-year timetable before the plan year ends that requires employee notification. 

If your plan does allow for hardship withdrawals, there could be other categories allowed, so it's important to check the list.  When looking at withdrawal requests from employees, make sure that each employee has:

• Provided written documentation of the hardship.
• Exhausted all other available assets, like a plan loan or do they own a second home which could be sold to prevent foreclosure.

Whatever you do, make certain that your hardship withdrawal request policy is applied uniformly. Make employees aware of the potential tax consequences of hardship withdrawals. These include a 10% penalty if the employee is younger than 59 1/2 and the distribution, which is considered income, could push the employee into a higher tax bracket. Plans can also require a period of suspension of future contributions after a hardship withdrawal. And unlike loans employees can never repay the money they take out for a hardship withdrawal.  Plans cannot accept a return of these funds. 

Check and double check your records and work with your plan administrator as soon as a hardship withdrawal request comes in. Don’t let an employee’s rush to get the funds result in mistakes and inconsistencies that could damage your plan.