IRS updates rules on retirement plan hardship distributions
By Lisa Tavares, Gregory Matisoff
Employers who allow for hardship distributions from their 401(k) or 403(b) plans should be aware that the Internal Revenue Service recently finalized updates to the hardship distribution regulations to reflect legislative changes. The new rules make the hardship distribution requirements more flexible and participant-friendly.
Hardship distributions are in-service distributions from 401(k) or 403(b) plans that are available only to participants with an immediate and heavy financial need. Plans are not required to offer hardship distributions. But there are certain requirements if a plan does offer hardship distributions. Generally, a hardship distribution may be made to a participant only if the participant has an immediate and heavy financial need, and the distribution is necessary and not in excess of the amount needed (plus related taxes or penalties) to satisfy that financial need.
An administrator of a 401(k) or 403(b) plan can determine whether a participant satisfies these requirements based on all of the facts and circumstances, or the administrator may rely on certain tests that the IRS has established, called safe harbors.
Over the last fifteen years, Congress has changed the laws that apply to hardship distributions. The new rules align existing IRS regulations with Congress’s legislative changes. Some of the changes are mandatory and some are optional. The new rules make the following changes. The following changes are required.
Elimination of six month suspension. Employers may no longer impose a six month suspension of employee elective deferrals following the receipt of a hardship distribution.
Required certification of financial need. Employers must now require participants to certify in writing or by other electronic means that they do not have sufficient cash or liquid assets reasonably available, in order to satisfy the financial need and qualify for a hardship distribution.
There were also some optional changes made to hardship distributions.
Removal of the requirement to take a plan loan. Employers have the option, but are not mandated, to eliminate the requirement that participants take a plan loan before qualifying for a hardship distribution. In order to qualify for a hardship distribution, participants are still required to first take all available distributions from all of the employer’s tax-qualified and nonqualified deferred compensation plans to satisfy the participant’s immediate and heavy financial need. The optional elimination of the plan loan requirement may first apply beginning January 1, 2019.
Expanded safe harbor expenses to qualify for hardship. The new hardship distribution regulations expand the existing list of pre-approved expenses that are deemed to be an immediate and heavy financial need. Prior to the new regulations, the list included the following expenses:
- Expenses for deductible medical care under Section 213(d) of the Internal Revenue Code;
- Costs related to the purchase of a principal residence;
- Payment of tuition and related expenses for a spouse, child, or dependent;
- Payment of amounts to prevent eviction or foreclosure related to the participant’s principal residence;
- Payments for burial or funeral expenses for a spouse, child, or dependent; and
- Expenses for repair of damage to a principal residence that would qualify for a casualty loss deduction under Section 165 of the Internal Revenue Code.
The new regulations expand this list of permissible expenses by adding a participant’s primary beneficiary under the plan as a person for whom medical, tuition and burial expenses can be incurred. The new regulations also clarify that the immediate and heavy financial need for principal residence repair and casualty loss expenses is not affected by recent changes to Section 165 of the Internal Revenue Code, which allows for a deduction of such expenses only if the principal residence is located in a federally declared disaster zone. Finally, the new regulations add an additional permissible financial need to the list above for expenses incurred due to federally declared disasters.
New contribution sources for hardships. The law and regulations provide that employers may now elect to allow participants to obtain hardship distributions from safe harbor contributions that employers use to satisfy nondiscrimination requirements, qualified nonelective elective contributions (QNECS), qualified matching contributions (QMACs) and earnings on elective deferral contributions. However, 403(b) plans are not permitted to make hardship distributions from earnings on elective deferrals, and QNECS and QMACs are distributable as hardship distributions only from 403(b) plans not held in a custodial account.
As this list indicates, the new regulations make substantial changes to the hardship distribution rules.
The deadline for adopting this amendment depends on the type of plan the employer maintains and when the employer elects to apply the changes. Plan sponsors should work with their document providers and legal counsel to determine the specific deadlines for making amendments.