Hardship Distributions are on the Rise: The Issues for Retirement Plan Sponsors and Participants

According to a recent Fidelity Investments’ white paper, hardship distributions have been on the rise since legislation was passed that makes it easier for participants to take them. Worse still, it appears that this increase is coming from individuals who might have otherwise taken loans from the plan to address their financial need. While it is always preferable for a participant to neither borrow nor withdraw from his/her account, loans are considerably favorable to hardship distributions for both parties. And thus, the increase in hardship distributions is bad news for plan sponsors and participants alike.

The Issues with Hardship Distributions

Multiple hardship distributions can be destructive to retirement savings, especially when compared to loans. Loans are paid back directly to the plan and do not come with a significant tax impact, thus preserving some retirement savings. On the other hand, hardship distributions are never repaid, and taxes assessed include the person’s income tax, plus a 10% penalty.

The tax implications of hardship distributions can also make a participant’s bad financial situation worse. In exchange for addressing the financial need of the hardship, participants end up owing the IRS a substantial amount for taking the distribution, which is typically due at tax filing in the year following the year of the distribution. Making matters worse is that many participants only incur a 10% tax withholding on their hardship distribution at the time of withdrawal, erroneously thinking that this is the entire amount of tax owed. For participants with needs requiring a hardship distribution in the first place, the additional tax bill could be a financial tipping point.

Additionally, hardship distributions have a far worse effect on average account balances than loans. Average participant account balances are a primary driver of recordkeeper pricing - typically, the higher the average account balance, the lower the recordkeeping fee. Because hardship distributions are not repaid to the plan, the overutilization can have a decidedly negative effect on average account balances, leading to less favorable pricing for everyone.

From a plan sponsor perspective, hardship distributions have the potential to be a compliance nightmare. Beginning in January of 2020, the final hardship regulations will require a participant self-certification. This self-certification states that an employee must represent that he or she has insufficient cash or other liquid assets to satisfy his/her hardship need. The plan administrator may rely on the employee’s representation, unless the plan administrator has actual knowledge to the contrary. As discussed in a Top of Mind post last year, this could lead to an administrative minefield, as the personnel responsible for the retirement plan may be aware of personal information regarding some employees, but not others. At a minimum, the new requirement appears to be a compliance headache, and the more hardship distributions a plan has, the more headaches there will be!

What Can Plan Sponsors Do?

While the increasing number of hardship distributions is concerning, plan sponsors can take some steps to help protect the plan and their participants. The final hardship distribution regulations permit plan sponsors to eliminate the requirement that all loans be exhausted prior to taking a hardship distribution, however, plan sponsors can still call for this in their plan. By steering participants in financial need to loans, rather than hardships, plan sponsors may be able to better protect both the plan and the individual.

Since hardship distributions are permitted from sources other than elective deferrals, through plan design, prudent plan sponsors can limit hardship distributions to as few contribution sources as possible. This, in turn, may help to reduce the number of hardship distributions taken. (Note that some of the additional sources, such as earnings on elective deferrals and employer contributions/QMACs/QNECs/QACAs that have been invested in a mutual fund, are already restricted with respect to 403(b) plans).


Not every plan sponsor has seen an uptick in hardship distributions, and thus it is important to review the plan’s hardship distribution data before taking any action. And, as a reminder, plan sponsors are not required to offer hardship distributions at all, so if hardship utilization is out of control, despite the best efforts of a plan sponsor, the more drastic step of amending the plan to eliminate hardship distributions entirely may be a prudent option.

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. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.

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