This question was answered by John Rich of the McLane Law Firm
Q: I own a small embroidery shop and one of my employees has asked to take money out of her 401(k) retirement plan - her husband has incurred a lot of medical expenses and is out of work. How do I determine if she can do this, and what do I need to know as a business owner to help her out?
A: You should read your 401(k) plan document or contact your plan service provider to determine whether the plan allows loans or distributions for hardship. However, there are numerous rules associated with all types of distributions that may be contained either in the plan document itself or in a written document forming part of the plan.
Let’s assume that the plan allows for loans and hardship distributions. The law does not require you to review financial statements or other indications of creditworthiness of each person who wants a loan. However, the maximum amount of a plan loan is limited by her vested account size. If her account is less than $10,000, she can borrow the entire account. If her account is greater than $10,000, she can borrow the greater of $10,000 or 50% of her vested account balance up to a maximum amount of $50,000.
The employee will need to figure out if the loan will give her enough money. Normally, a loan is the first choice because the loan is repaid with interest so the money will be there for retirement and no taxes are paid on the distribution. Most employers use payroll deductions for loan repayments so the employer can avoid collection problems.
Since an employee is only able to take a loan of up to 50% of the vested account balance, the employee may also need a withdrawal. A withdrawal can be made for hardship if the employee (or employee's spouse, dependent or beneficiary) has an immediate and heavy financial need such as the payment of medical expenses. The plan will specify what information must be provided to the employer to demonstrate a hardship but most plans do not require an inquiry into the employee's financial status. Unlike loans, hardship distributions are included in the employee’s income.
Regardless of the type of distribution, you will need to work with your plan service provider to make sure all the necessary paperwork is completed.
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