What documentation is needed for hardship withdrawal from 401k

Emergency Access to Your 401k: Hardship Withdrawals

It can be pretty satisfying to get your 401k statement in the mail and see the good-sized balance that you've built. After contributing for several years, it's becoming easier to imagine all of the things that you'll be able to do with that money when you retire.

Then the doctor bill comes, or the tuition bill, or a late notice from your mortgage company. Suddenly, the pie-in-the-sky picture of retirement seems meaningless in the face of your current problems. So, can you access that 401k money to cover these sorts of hardships?

Yes, if your plan allows it.

To get at the money, however, you'll have to weave your way through a veritable obstacle course of regulations. You'll need to prove that you really need the money right now, says Jim Stone, a Chartered Financial Consultant (ChFC) and an instructor at the College for Financial Planning. "The financial hardship provision allows withdrawals only for immediate, pressing need," said Stone.

Reasons that people apply for hardship withdrawals vary from the whimsical, such as a trip to the Caribbean (which won't be approved), to the agonizing, such as paying for a child's leukemia treatment (which probably will). But, there are only four IRS-approved reasons for making a hardship withdrawal: college tuition for yourself or a dependent, provided it's due within the next 12 months; a down payment on a primary residence; unreimbursed medical expenses for you or your dependents; or to prevent foreclosure or eviction from your home.

It should be noted that, if your plan permits, you can take a loan from your 401k. And, while you can avoid penalties and taxes with loans (with a hardship withdrawal you can't), they must be paid back.

Forty-eight percent of the people who have taken a hardship withdrawal have done so to buy a home, according to a study conducted by the Investment Company Institute (ICI) in the spring of 2000. Other reasons cited were medical emergency (28 percent), bills or daily expenses (21 percent), and education (7 percent).

If you are exploring the idea of using the hardship withdrawal provision, make sure that you aren't making the decision lightly. Financial planners consistently stress that your 401k account does not work very well as a savings account or emergency fund -- the money is hard to get, the process is time consuming, and the damage you can do to your retirement savings account can take many years to repair.

The Approval Process

Before you begin: You will be in for a lot of paperwork if you decide to take a hardship withdrawal. Before beginning the process, you might consider discussing your financial situation and options with a financial planner.

The legally permissible reasons for taking a hardship withdrawal are very limited. And, your plan is not required to approve your request even if you have an IRS-approved reason.

The IRS allows hardship withdrawals for only the following reasons:

1. Unreimbursed medical expenses for you, your spouse, or dependents.
2. Purchase of an employee's principal residence.
3. Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
4. Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
5. For funeral expenses.
6. Certain expenses for the repair of damage to the employee's principal residence.

How it Works

If your plan allows hardship withdrawals, your request will need to be approved either by a committee or a designated representative who has agreed to accept the legal responsibility for making the decision. Because there are a lot of legal issues surrounding hardship withdrawals, the approval process can be very strict; these are rarely "rubber stamp" decisions.

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This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

​Employees no longer routinely have to provide their employers with documentation proving they need a hardship withdrawal from their 401(k) accounts, according to the Internal Revenue Service (IRS). Employees do, however, need to keep source documents, such as bills that resulted in the need for hardship withdrawals, in case employers are audited by the IRS, the agency said.

Due to uncertainties in how the IRS would handle audits, conservative employers may still choose to require employees to provide source documentation even before audits, said Marcia Wagner, an attorney with The Wagner Law Group in Boston.

In recent years, many institutions administering the records for 401(k) accounts have allowed employees to report on the account administrator's website that they have a hardship and need to make a withdrawal, without requiring them to submit documentation or bills to show why they need the money, noted Brenna Clark, an attorney with Eversheds Sutherland in Atlanta. But if those 401(k) plans were audited, IRS agents would ask the employers for proof that the withdrawals were due to hardships. Agents did not think the self-certification electronic policy was enough, Clark said, and expected these third-party record-keepers or employers to have copies of the bills that gave rise to the hardship withdrawals.

In 2015, the IRS issued a newsletter saying that employers should ask for and keep physical proof of the need for hardship withdrawals, such as medical bills. An employee providing a summary of the cause for withdrawal on the third-party record-keeper's website was not enough, she noted.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

But in a Feb. 23 memorandum to IRS agents, the agency changed its position on the documents needed to substantiate a hardship withdrawal, Wagner said. "Previously, the IRS would be looking for source documents to substantiate a hardship withdrawal," she said. "But the new guidance permits the use of a summary of the information contained in the source documents."

Under this guidance, to rely on a summary of information, the third-party record-keeper or employer needs to send the employee a notice that requires the employee to agree to preserve the underlying source documents (e.g., bills) and make them available at any time upon the request of the employer or third-party record-keeper.

Hardship Information

Source documents for these specific hardship withdrawals should note:
Medical care

• Who incurred the medical expenses?
  
• What is the relationship to the participant (self, spouse, dependent or primary beneficiary under the plan)?
  
• What was the purpose of the medical care (e.g., diagnosis, treatment, prevention or long-term care)?
  
• What is the name and address of the service provider?
  
• What amount of medical expenses was not covered by insurance?
  

Purchase of principal residence

• Will this be the participant's principal residence?
  
• What is the address of the residence?
  
• What is the purchase price of the principal residence?
  
• What are the types of covered costs and expenses (e.g., down payment, closing costs and title fees)?
  
• What is the name and address of the lender?
  
• What is the date of the purchase or sale agreement?
  
• What is the expected date of closing?
  

Educational payments

• Who are the educational payments for?
  
• What is the relationship to the participant?
  
• What is the name and address of the educational institution?
  
• What are the categories of educational payments involved (e.g., post-high school tuition, related fees, room and board)?
  
• What is the period covered by the educational payments?
  

Foreclosure/eviction from principal residence

• Is this the participant's principal residence?
  
• What is the address of the residence?
  
• What is the type of event—foreclosure or eviction?
  
• What is the name and address of the party that issued the foreclosure or eviction notice?
  
• What is the date of the notice of foreclosure or eviction?
  
• What is the due date of the payment to avoid foreclosure or eviction?
  

Funeral and burial expenses

• What is the name of the deceased?
  
• What is the relationship of the deceased to the plan participant?
  
• What is the date of death?
  
• What is the name and address of the service provider (e.g., cemetery or funeral home)?
  

Repairs for damage to principal residence

• Is this the participant's principal residence?
  
• What is the address of the residence that sustained damage?
  
• What is the cause of the casualty loss (e.g., fire, flooding or type of weather-related damage), including the date of the loss?
  
• What are the repairs and their date, and are they are in process or completed?
  

"If any of those items was omitted from the summary, the summary would be incomplete," Wagner observed.

Be careful of inconsistencies such as a medical service invoice for services after a funeral date or an expense for a casualty loss prior to the date of the casualty, she noted. "In these circumstances, the agent will ask the employer or the TPA [third-party administrator] for the source documentation. This is where a potential risk exists for the employer and why the IRS has in the past been reluctant to accept self-certification."

The information may have been lost or misplaced or the employee no longer works for the employer by the time the audit is conducted years later. "It is unclear from the memorandum what action the agent would take in this circumstance, and it might depend upon how serious the incomplete or inconsistent summary was," she noted.

Employees Should Keep Documentation

Employers and third-party record-keepers should at the very least make it clear to the employee that he or she should keep physical proof of the need for the hardship withdrawal and make the proof available at any time on request by the employer, Clark said. If employers are allowing employees to take more than two hardship withdrawals a year, they might require physical proof up front rather than waiting for an IRS audit, she added. Or an employer could limit employees to two hardship withdrawals a year.

Some employers prefer for employees to have unlimited access to their accounts, she noted. However, other plans prefer to help employees to keep their money in the plan and grow it for retirement. The difference in treatment comes down to employers' philosophy toward hardship withdrawals, Clark said.

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