November 13, 2017
Question: Our company terminated its calendar-year 401(k) plan effective December 31, 2016, but will not make final plan distributions until the IRS issues a favorable determination on the plan’s termination. Should we file a final Form 5500 for the plan year in which the termination was effective (2016), or the plan year in which the final distributions are paid?
Answer: The final Form 5500 is filed only after all of a plan’s assets have been distributed to the plan’s participants and beneficiaries or transferred to another plan. If a plan is terminated but all assets aren’t distributed, the plan administrator is required to file Form 5500 for each plan year in which assets remain in the plan’s trust. The final plan year ends on whatever date the distribution of plan assets is completed. The final Form 5500 is due seven months after this date, unless the plan administrator obtains an extension. Significantly, if a Form 5500 is marked as final, but shows assets remaining at the end of the plan year being reported, it’s likely to trigger correspondence from the IRS. As illustrated in the examples below, the final plan year likely will be a short plan year. The final Form 5500 should show zero assets at the end of the short plan year.
As your company has done, a plan sponsor may (but is not required to) seek an IRS determination letter on the plan’s qualified status at termination. Requesting a determination letter delays the distribution process, but it can give the plan sponsor and participants comfort that the plan remained qualified in form at the time of termination, and that eligible distributions made from the plan on termination can be rolled over.
- Example: Final Distributions Made in 2017. Your plan administrator must file Form 5500 for the 2016 plan year as an ongoing plan because, on January 1, 2017, assets remained in the plan’s trust. (The filing deadline would be July 31, 2017, unless an extension applied.) If the IRS issues a favorable determination on your plan’s termination in October 2017, and the last distribution of plan assets occurs on December 2, 2017, then the final Form 5500 would be filed for that short plan year (beginning January 1, 2017 and ending December 2, 2017). It would be due seven months after December 2, 2017 unless an extension applies. (Note: The automatic corporate extension won’t be available for the short plan year because the plan year’s end date will not be the same as the corporate tax year.)
- Example: Final Distributions Made in 2018. If the IRS doesn’t issue a favorable determination on your plan’s termination until sometime in 2018, then you would file Form 5500 for the 2017 plan year as an ongoing plan because, on January 1, 2018, assets would remain in the plan’s trust. (The filing deadline would be July 31, 2018, unless an extension applies.) Let’s say you receive the favorable determination from the IRS on January 8, 2018 and the last distribution of plan assets occurs on February 26, 2018. Then you would file a final Form 5500 for that short plan year (January 1, 2017 through February 26, 2018). As explained above, it would be due seven months after February 26, 2018 unless an extension applies.
Contact your tax or employee benefits advisor for more information.
Question: Our third party administrator provides an electronic system for our 401(k) participants to make and change their deferral elections, choose and change investments, and request distributions, including requests for hardship distributions.
Can we avoid collecting any hardship-related documents from participants in our 401(k) plan by allowing them to certify electronically that they satisfy all requirements for a hardship distribution?
Answer: Unfortunately, not all of the hardship conditions can be met by self-certification. A 401(k) plan can make a hardship distribution only if the participant experiences an “immediate and heavy financial need” and a hardship distribution is “necessary to satisfy the financial need.”
While the regulations allow a participant to self-certify that a requested distribution is the sole way to alleviate a financial need (that is, other resources are lacking), self-certification is not sufficient to show the nature of a hardship (in terms of the type and amount of the need).
Informally, the IRS has stated that a plan should obtain and maintain the following records in paper or electronic format for hardship distributions:
- Documentation of the hardship distribution request, review, and approval;
- Financial information and documentation substantiating the participant’s financial need;
- Documentation to support that the distribution was properly made in accordance with the Code’s hardship rules and applicable plan provisions; and
- Proof that the distribution was made and that Form 1099-R was filed reporting the distribution.
Self-certification can be used in lieu of collecting any information or documents about the participant’s lack of other resources to meet the financial need.
Alternatively, a plan may use a safe harbor that uses information known to the sponsor and a minimum required suspension of deferrals to relieve the plan of having to collect documentation about the participant’s lack of other resources.
These strategies address only whether the distribution is “necessary,” and do not eliminate the need to document the nature of the participant’s hardship. The plan must request and retain documentation such as bills or legal documents establishing the nature of the hardship.
In the IRS’s view, not requesting and retaining documentation needed to substantiate a participant’s financial hardship is an operational qualification failure that requires correction under the Employee Plans Compliance Resolution System.
Even when a third party administrator maintains hardship distribution records, it’s ultimately the plan sponsor’s responsibility to ensure those records are retained (in electronic or paper format) so that they are available to support the plan’s decision in the event of an audit or dispute.