Best Practices in Hardship Withdrawals Documentation

Tax Professionals' Resource
February 8, 2013 — 2,331 views  
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When facing a difficult financial situation, emergency hardship withdrawal may be the only answer. The plans that allow for such hardship withdrawal are 401(k), 403(b) and 457(b). Before processing such documentation, it is important to fully understand what is defined as hardship and what the best practices should be followed when handling this type of documentation.

What is Hardship?

Under the IRS (Internal Revenue Service), hardship is seen as an immediate financial need of the individual or his/her spouse, child, or legal dependent. The financial needs outlined include:

-         Medical expenses
-         Purchase of a primary residence
-         Prevent eviction/foreclosure of primary residence
-         Post-secondary educational fees and expenses
-         Funeral expenses
-         Repairs with regard to the individual’s primary residence

Whether or not hardship withdrawal can be claimed depends on situation and circumstances. Hardship withdrawal may include any amount necessary for payment of incidental taxes and penalties resulting directly from the distribution.

How can an individual qualify for Hardship Withdrawals?

In order to file for or request hardship withdrawals, the individual or employee must show that his/her financial needs cannot be satisfied by:

-         Reimbursement through insurance policy
-         Liquidation of assets
-         Stopping elective contributions
-         Other distributions or non-taxable loans
-         Loans from commercial sources

Required Documentation

If an individual or employee’s plan allows for withdrawal on hardship, the necessary documentation may vary depending on the reasons stated for the distribution.

Medical Expenses:

-         Letter of denial for loan application from a commercial bank or source.
-         Copies of all medical bills showing portions covered by insurance as well.
-         If bills are for spouse or dependant, copies of all tax documents or marriage certificate are required to prove relationship.
-         Ifno portions of the bills are covered by insurance, a letter from the insurance company, detailing the reasons, should be provided.
-         If the individual has no insurance coverage, proof in the form of documentation showing no elective for insurance coverage is required.

Purchase of a Primary Residence:

-         Letter of denial for loan applied with a commercial bank or other source.
-         Copy of property purchase agreement with signatures of the buyer and seller, which mentions the balance that is to be paid by utilizing the hardship withdrawal.

Prevent eviction/foreclosure of primary residence:

-         Letter of denial for loan application from a bank or lender
-         Notice of eviction/foreclosure mentioning the date of impending eviction/foreclosure and the amount needed to prevent it. This applies to foreclosures of primary residence only.
-         If the residence rented from a private owner and not a rental company, a copy of the original lease agreement is required.
-         If eviction/foreclosure is executed on spouse’s property or dependant’s property, copies of all tax documents or marriage certificate to prove relationship are essential.

Post-Secondary Educational Fees and Expenses:

-         Letter of denial for loan applied with a bank or lender.
-         School invoice or tuition statement with the student’s name and amount owed. Invoice can only be the one received in the current quarter or semester and/or for the next 12 months, but not for the period past schooling.
-         If the student is the employee’s spouse or dependant, copies of all tax documents or marriage certificate are essential.

Funeral Expenses:

-         Letter of denial for loan application, which is sent by a commercial bank or other source
-         Copies of bills bearing the employee’s name
-         Proof of relationship of the deceased with the employee

Repairs with Regard to the Individual’s Primary Residence:

-         Letter of denial in regard to a loan, which is received from a bank or lender
-         Copy of the estimated cost.
-         If repairs are not covered by homeowner’s insurance, letter of denial of coverage from the insurance company is required.

All documentation must be submitted for the hardship withdrawal to be considered, but it does not guarantee approval of the request. In special cases, additional documentation may be requested if necessary.

Tax Professionals' Resource