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Is a Retirement-Plan Hardship Distribution a Recovery Option for Your Employees?

November 17, 2021
Michael Kuehnle
Michael Kuehnle

Due to the destruction and disruption recent hurricanes brought to the region, many residents need funding to put their homes and lives back together. If you are a business owner, some of those cash-strapped residents could be your employees — and some could be asking about a feature you may or may not have in your retirement plan: the hardship distribution.


Retirement Plan Hardship Distribution


Many elective deferral retirement plans — 401(k), 403(b) and 457(b) — allow for premature distribution of plan funds to participants. One IRS-accepted reason for a hardship withdrawal is “expenses and losses incurred on the account of a federally declared disaster.”

If your business opted for the hardship distribution feature when you established your plan, and you have an employee with recovery needs who either resides or works in an area designated by the federal government for disaster assistance, the employee may come to you or your plan administrator looking to discuss tapping into plan assets.

What plan participants need to understand

When you have that conversation, here are some things to make sure the employee understands:

Hardship distributions should be a last resort for addressing recovery needs. There are drawbacks to hardship distributions that make most other funding options preferable:

  • Tax consequences. In addition to being taxed as ordinary income, hardship distributions are subject to an excise tax.
  • A drain on retirement savings. With pensions in many industries having gone the way of the dinosaur, retirement plans like a 401(k) are often an employee’s primary or only retirement savings vehicle. Hardship distributions can diminish those savings and threaten the employee’s long-term security.

If your plan offers a loan option, that may be a better funding alternative for the employee. Taking out a plan loan would only have tax consequences if the employee defaults on the loan, and the employee can pay it back with interest to avoid any drain on savings. Another consideration when determining if a plan loan is the best option: Plan loans require the employee to repay the loan with after-tax dollars, not the pre-tax dollars funding the plan.

Employees need to document their eligibility. According to IRS rules, a plan participant is only eligible for a hardship distribution if:

  • The withdrawal is due to an immediate and heavy financial need. 
  • The withdrawal is necessary to satisfy that need (i.e., the employee’s household has no other assets that could be used to meet the need).

Employees must provide your organization’s plan administrator or record keeper with documents showing they meet these criteria.

There are limitations on distribution amounts. Employees cannot withdraw more than the amount necessary to meet the need. In other words, if the need is replacing a storm-damaged roof, and the roof costs $10,000, that’s all they can withdraw.

Additionally, employees typically can’t withdraw more than the vested amount they have in the plan.

A caveat for plan sponsors

Employers should be diligent when reviewing plan participants’ requests for hardship distributions to ensure they meet IRS requirements. If there is ever an IRS audit, it’s important to understand who beyond the participant would have culpability if the IRS deemed a withdrawal excessive or illegitimate. Every plan’s administrative set-up is different, but in some cases the plan administrator or fiduciary could have individual exposure.


How Hancock Whitney can help

If your plan doesn’t offer a hardship distribution or loan feature, and you’d like to consider adding one or both to better assist your employees in meeting future emergency financing needs, a Retirement Plan Services professional can review these optional provisions with you.


The information, views, opinions, and positions expressed by the author(s), presenter(s), and/or presented in the article are those of the author or individual who made the statement and do not necessarily reflect the policies, views, opinions, and positions of Hancock Whitney Bank. Hancock Whitney makes no representations as to the accuracy, completeness, timeliness, suitability, or validity of any information presented.

This information is general in nature and is provided for educational purposes only. Information provided and statements made should not be relied on or interpreted as accounting, financial planning, investment, legal, or tax advice. Hancock Whitney Bank encourages you to consult a professional for advice applicable to your specific situation.

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