Two years ago the US Internal Revenue Service (IRS) said in one of its Employee Plans newsletters that plan sponsors were required to retain—for production on audit—documentation to substantiate 401(k) hardship withdrawals. This requirement appeared to be substantially more rigorous than the hardship withdrawal procedures followed by many plan sponsors and service providers. Those procedures typically required retention of summary information, rather than actual documents, critical to substantiation of participant hardships.
A February 23, 2017 Field Directive addressing audit guidelines for substantiation of hardship withdrawals appears to indicate the IRS’s acceptance of those common practices. It says that auditors may substantiate hardship withdrawals based on either source documents themselves or summaries of critical information from source documents. Where summaries are used, the Field Directive provides lists of relevant information that must be contained in the summaries and notifications that must be provided to participants requesting hardship withdrawals. Where summaries are incomplete, auditors are directed to request source documents. The IRS has said informally that those documents may be provided directly to the auditor by participants, rather than through the plan sponsor or service provider. Finally, if summaries are prepared and retained by service providers, the Field Directive says that plan sponsors should receive annual reports from the service providers covering those summaries.
Plan sponsors should familiarize themselves with these new audit standards and ensure that they and their auditors and service providers follow compliant procedures.