Author: Steven Grieb
In recent years, legislation has expanded the idea of defined contribution retirement plan administrators relying on certifications by participants that they are eligible for an in-service distribution. From an administrative perspective, the idea of participants self-certifying a distribution can be very attractive. However, fiduciaries may want to consider what's best for their plan, based upon early experience with the self-certification process.
Hardship self-certification under SECURE 2.0
Following the passage of the SECURE 2.0 Act of 2022 (SECURE 2.0), plan administrators may rely on employee representations when they apply for a hardship distribution. Specifically, after SECURE 2.0, plan administrators may rely on a participant's certification that (1) they experienced an event that qualifies for a safe harbor hardship distribution, (2) the amount they have requested doesn't exceed the amount needed to satisfy the hardship (plus taxes) and (3) the participant has no alternative means available to satisfy the need.
There is nothing in SECURE 2.0 or other IRS guidance requiring plan administrators to permit self-certification. Plans could continue to require specific documentation from the participant for each hardship payment if they chose to. SECURE 2.0 states the IRS "may" issue regulations providing that plan administrators cannot rely upon participant representations if they have actual knowledge to the contrary, and laying out the process and requirements in cases of participant misrepresentation. To date, however, the IRS hasn't issued regulations relating to the self-certification of hardship distributions.
Without that guidance, the responsibilities and risks of permitting self-certification involve significant gray areas. Substantial questions remain about what happens if a participant misrepresents the facts on a hardship distribution request. While the IRS would likely not disqualify a retirement plan when the plan administrator lacked actual knowledge of the participant's dishonesty, the ultimate consequences aren't certain.
Other in-service distribution self-certifications
There are several other in-service distributions that allow plan administrators to rely on the representations of participants, including (1) distributions to victims of domestic abuse, (2) emergency expense distributions and (3) distributions upon the birth or adoption of a child.
These distributions might be preferable to participants, because they aren't subject to the 10% penalty on early distributions if the participant is under age 59½. Additionally, these distributions can be repaid into the plan within a certain period. Hardship distributions are subject to the 10% early distribution penalty and cannot be repaid into the plan.
Leakage concerns
Initially, plan administrators may be eager to allow self-certification of distributions. Why incur the extra effort and expense requesting and approving documentation from the participant when you could simply request they make certain representations? By eliminating the requirement for documentation, self-certification can reduce administrative burdens and improve access in cases of legitimate financial need.
However, it also decreases the mental and emotional hurdles to accessing savings that have been set aside for the participant's retirement. As plans have begun adopting self-certification procedures, there has been a noticeable increase in hardship distributions. Leakage from improper distributions can materially erode a participant's retirement readiness.
As more participants understand they can self-certify certain distributions, word can spread within an employee group. Difficult financial conditions can cause some participants to take advantage of the new rules. Gallagher has encountered specific instances where participants have certified eligibility for repeated hardships and domestic abuse distributions within a single year.
Steps to consider
Despite SECURE 2.0 allowing for self-certification, plan administrators may choose to retain control over the distribution process. The IRS expects that plan sponsors continue to review the plan's overall withdrawal activity, and auditors may request proof of such review. As an alternative to requiring a full documentation procedure, a plan could permit self-certification, but request documentation in cases where the participant has requested more than two distributions in a year or under other suspicious circumstances. Plans can also limit the number of hardship (or other in-service) distributions allowed in a single plan year.
Other potential steps that plan administrators should consider include:
- Maintain and follow a uniform hardship distribution policy for all participants
- Review distribution application forms to help ensure participants make the necessary representations
- Review and retain the distribution applications
- If you have actual knowledge that contradicts the certification, scrutinize the application and discuss with the participant. Deny the distribution request if necessary
- Monitor for repeated distribution requests or other patterns that suggest abuse
- Participant education should make participants aware of the distribution requirements and the consequences of misrepresentations on a distribution application
- If your recordkeeper or TPA administers distributions, ask to review their procedures, particularly for participant self-certification. Confirm they retain the records relating to distributions for an appropriate period.
Gallagher insight
Allowing participants to self-certify distributions might offer several advantages. It might remove some discretion. It could also expedite and simplify the claims process, lowering plan expenses. It can limit an employer's exposure to information they might prefer not to know. However, it also poses real risks around retirement savings leakage. Until the IRS provides guidance around the self-certification process, significant uncertainty will remain.
Plan administrators should work closely with their recordkeepers or TPAs, legal counsel and their Gallagher consultant to determine the best approach in dealing with hardship and other distribution requests. As always, your Gallagher representative is here to help you assess potential risks and develop a distribution process that is proper for your specific plan.
