IRS doesn't audit individuals for 401(k) hardship withdrawals, AS LONG AS the employer sponsor of the plan and it's administrator (your employer and Fidelity) have approved it. The entity that will be audited is the plan/sponsor/ administrator.
Lying to get a 401(k) hardship withdrawal can have serious consequences, such as legal repercussions in the form of fraud, financial penalties, and tax implications. If you're caught lying about legibility for a hardship withdrawal, you may face additional fees, fines, and even imprisonment.
The short answer is yes — if you make a 401(k) withdrawal, your employer will know.
Hardship distributions are includible in gross income unless they consist of designated Roth contributions. In addition, they may be subject to an additional tax on early distributions of elective contributions. Unlike loans, hardship distributions are not repaid to the plan.
You do not have to prove hardship to take a withdrawal from your 401(k). That is, you are not required to provide your employer with documentation attesting to your hardship.
Taking early withdrawals from retirement accounts
These withdrawals must meet certain criteria in order to avoid taxation and penalties. Therefore, the IRS keeps an eye out for unreported early retirement account withdrawals that don't meet the criteria and are therefore taxable.
You must pay income tax on any previously untaxed money you receive as a hardship distribution. You may also have to pay an additional 10% tax, unless you're age 59½ or older or qualify for another exception. You may not be able to contribute to your account for six months after you receive the hardship distribution.
Will your employer know if you take out a 401(k) loan? Yes, it's likely your employer will know about any loan from their own sponsored plan. You may need to go through the human resources (HR) department to request the loan and you'd pay it back through payroll deductions, which they'd also be aware of.
Acceptable Documentation
Lost Employment. • Unemployment Compensation Statement. (Note: this satisfies the proof of income requirement as well.) • Termination/Furlough letter from Employer. • Pay stub from previous employer with.
While the IRS sets general guidelines, individual 401(k) plans determine whether and how hardship withdrawals are allowed for participants. In some circumstances, you will have to pay a 10% penalty for an early withdrawal, though other reasons will incur no penalty.
If your business has 100 or more eligible participants at the beginning of the plan year, you must undergo a 401(k) audit through a third party. The “keyword” in this situation is “eligible,” so even if some of your employees choose not to participate, they still count toward the audit requirement.
Large changes of income
Probably one of the main IRS audit triggers is a large change of income.
While there isn't technically a limit on the number of 401(k) hardship withdrawals you're allowed in a year, you are limited by whether you qualify and whether you have enough money in your 401(k) to cover the qualifying hardship amount.
Your employer plays a role in administering 401(k) plans and may need to approve withdrawals in certain situations, such as in-service withdrawals or hardship distributions.
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
Your employer technically will always know when you borrow money from your 401(k). One of the tricky parts about managing a 401(k) loan is that, even though this money belongs to you, your employer can set terms and conditions around taking the loan.
Many plans approve hardship withdrawals through a self-certification process where you provide a written statement confirming: Your distribution meets the plan requirements and is for one of the approved “immediate and heavy financial needs.”
The consequences of false hardship withdrawal can range from fines and penalties to tax implications or even jail time. Additionally, lying to an employer can severely hinder your career growth or result in job loss. In other words, if you don't qualify, seek an alternative solution.
Key takeaways
A 401(k) loan may be a better option than a traditional hardship withdrawal, if it's available. In most cases, loans are an option only for active employees. If you opt for a 401(k) loan or withdrawal, take steps to keep your retirement savings on track so you don't set yourself back.
Businesses that show losses are more likely to be audited, especially if the losses are recurring. The IRS might suspect that you must be making more money than you're reporting—otherwise, why would you stay in business? Most likely to be audited are taxpayers reporting small business losses.
When you take a distribution from your 401(k), your retirement plan will send you a Form 1099-R. This tax form shows how much you withdrew overall and the federal and state taxes withheld from the distribution if applicable.
You will not need to submit any documentation with your application to prove that you meet all of the qualifications to take a hardship withdrawal. As part of the application, you will certify that you meet all of the requirements to receive a hardship withdrawal.