A Warning to 401(k) Plan Sponsors Relying on Third-Party Administrators (TPAs)

A recent news bulletin from the IRS serves as a cautionary reminder that plan sponsors retain responsibility for the proper administration of participant hardship distributions and loans, and related recordkeeping requirements, even when they use a TPA.

Plan Recordkeeping

As stated in the bulletin, the plan sponsor should retain the following (in paper or electronic format):

For hardship distributions,

  • documentation of the hardship request, review and approval;
  • financial records that substantiate the immediate and heavy financial need that is the basis for the hardship distribution;
  • documents that support the hardship distribution made in accordance with the terms of the plan and Internal Revenue Code provisions; and
  • proof of the hardship distribution from the plan and the Form 1099-R.

For loans,

  • documentation of the loan application, review and approval process;
  • an executed plan loan note;
  • if applicable, evidence showing the loan proceeds were used to purchase or construct a primary residence;
  • evidence of loan repayment; and
  • documents that show plan collection efforts on a defaulted loan, with related Forms 1099-R, if applicable.

Note that the IRS does not accept participant self-certification as sufficient documentation of i) the nature of a hardship, or ii) eligibility for loans to purchase/construct a primary residence with repayment terms in excess of five years.  Also, the IRS notes that plan sponsors may not rely on plan participants to keep their own records (since the plan sponsor may not have access to those records in the event of a plan audit).

Plan Sponsor Action Items

As the IRS has made clear, plan sponsors may not abdicate total responsibility to their TPAs to accurately track the administration and retain documentation of participant hardship distributions and loans.  Therefore, plan sponsors should review plan records frequently, and ensure that they have regular access to, and can frequently audit, TPA records to remedy deficiencies as they occur.  TPA service agreements should be drafted accordingly.

As the IRS points out, failure to have plan records available for examination by the IRS in the event of an audit is a plan qualification failure that plan sponsors should correct using the Employee Plans Compliance Resolution System (EPCRS), which could entail a filing (or other dealings) with the IRS or self-correction.

Other Related News

In a welcome development for plan sponsors, the IRS recently issued modifications to EPCRS, including a change to the method for determining the filing fee for a Voluntary Correction Program (VCP) submission that relates solely to participant loan failures.  The VCP fee for loan failures generally is now calculated based on the number of participants with loan failures, instead of the overall number of participants in the plan.  This change is particularly beneficial to large plans that have a small number of loan failures.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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