What Kind of Payments Can a Hardship Request Cover When Buying a Home?

We are a large health care provider that sponsors a 401(K) plan for our employees. I read your recent Ask the Experts column on the 401(k) rules for hardship distributions, which stated that one of the expense categories that constitutes an “immediate and heavy financial need” for hardship distribution purposes is “Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments)”. My question is: can a hardship request to cover costs directly related to the purchase of a principal residence for the employee include payoff of outstanding debts if that is what is required for the participant to qualify for the mortgage loan?

Kimberly Boberg, Taylor Costanzo, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

Presuming that your 401(k) plan is satisfying the safe harbor method of determining what constitutes an “immediate and heavy financial need” for hardship distributions, and is including this particular expense as a category, probably not, though you should consult with retirement plan counsel on the specifics of this particular situation. The reason why it would probably not qualify is twofold.

1. It is not a DIRECT expense of the purchase (satisfying debts unrelated to the residence in order to be able to qualify for a mortgage loan to purchase the residence is an indirect expense of purchasing the residence). Direct expenses of the principal residence generally include any cash down payment and any other cash due at closing, as opposed to cash due for other purposes related to home financing, such as mortgage payments or private mortgage insurance that is not due at the time of closing, as well as any other payments necessary for mortgage qualification.
2. The hardship provisions as to what constitutes an “immediate and heavy financial need” are a safe harbor, meaning the plan sponsor is not required to follow them. As such, they are generally not intended to be interpreted broadly.

Of course, your plan can elect not to follow the safe harbor hardship withdrawal provisions and allow hardship distributions to be made for the reason you cited. However, upon audit, any determinations that you make with respect to hardship as a plan sponsor will be subject to a facts-and-circumstances review by the IRS, which is why many plan sponsors elect to utilize the safe harbor hardship provisions.

NOTE: This feature is to provide general information only, does not constitute legal advice and cannot be used or substituted for legal or tax advice. 

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Amy.Resnick@issgovernance.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future column.