Generally, hardship withdrawals are restricted to funds from the participants' elective deferrals. A plan may permit hardship withdrawals from certain types of employer contributions, as well. Many plans limit the withdrawal of employer contributions because of complications that can arise when a participant is only partially vested.

May a plan permit hardship withdrawals of employer contributions?

Yes, although qualified and safe-harbor contributions are not available for hardship withdrawal, other employer contributions may be withdrawn if the plan design permits it. If the employer contributions are not fully vested when the participant applies for a hardship withdrawal, only the vested portion of his or her account may be withdrawn. This will complicate future vesting calculations.

For example, let's say a participant has $10,000 of employer contributions that are 40% vested at the end of year three on a six-year graded vesting schedule. The participant withdraws $2,000 as a hardship distribution. Even though only $8,000 remains, the vesting schedule is based on $10,000. Thus, 20% of $10,000, or an additional $2,000, would become vested the next year. So of the remaining $8,000 in the account, $4,000 would be vested at the end of year four.

This calculation becomes even more complicated if additional employer contributions are made. Using the above example, if the employer makes a contribution of $1,800 in year four, the vested amount is $5,080 ($11,800 x 60% less $2,000). While the vested amount is correct on the statement, there could be some confusion when the account balance is shown as $9,800 and the participant is 60% vested, leading the participant to possibly believe that he or she has a vested balance of $5,880. Accuracy may suffer in these situations, especially if there is a change in recordkeepers and the hardship distribution and thus it's impact on the vesting is unknown to the new recordkeeper or the participant terminates before becoming fully vested.