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IRS Regulations Finalize Rules Relating to Hardship Distributions

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Julie L. Hamlet, Mindi M. Johnson and Amanda J. Dernovshek
Employee Benefits Law Update E-blast
December 3, 2019

In September of this year, the IRS issued final regulations that expanded the availability of hardship distributions under 401(k) and 403(b) plans (the “Regulations”). The Regulations reflect the changes that were implemented by the Bipartisan Budget Act of 2018 (the “Act”), and address many of the questions that were left unanswered by the Act. (See here for our previous blog entry regarding the changes that were implemented under the Act). A summary of the Regulations appears below.

A. Expansion of Safe Harbor Expenses

As a general rule, a hardship distribution is permitted under a 401(k) or 403(b) plan only if (1) the distribution is on account of an immediate and heavy financial need; and (2) the amount of the distribution does not exceed the amount necessary to satisfy that need. The old hardship distribution regulations provide a safe harbor under which distributions for six types of expenses are deemed to be made on account of an immediate and heavy financial need. The Regulations have expanded the safe harbor as indicated below.

  1. The Regulations codified prior sub-regulatory IRS guidance by adding a new class of individuals for whom qualifying medical, educational, and funeral expenses may be incurred. This new class includes any “primary beneficiary under the plan.”
  2. The Regulations restored the safe harbor that applies to expenses that qualify for a casualty loss deduction under Internal Revenue Code 165 (e.g., costs to repair damage a principal residence). The Tax Cuts and Jobs Act, enacted in 2017, had eliminated the casualty loss deduction unless the loss was due to a federally-declared disaster. The Regulations would allow plans to disregard this provision so that hardship distributions can be taken for any casualty loss.
  3. The Regulations added a seventh type of “safe harbor” expense that applies to any expenses or losses that are incurred as a result of a federally declared disaster. This change is intended to allow affected participants to immediately access plan funds after such a disaster without having to wait for the IRS to provide guidance that is specific to each disaster. Now, employees with a principal residence or a principal place of business in an area that has suffered a natural disaster, as declared by the Federal Emergency Management Agency, may access these funds.

The revised list of safe harbor expenses may be applied to distributions that are made on or after a date that is as early as January 1, 2018. For example, if a plan continued to allow for casualty loss hardship distributions without regard to the changes imposed by the Tax Cuts and Jobs Act, it could be retroactively amended to conform to the new Regulations.

B. Elimination of Six-Month Suspension of Contributions

The Regulations eliminate the requirement that an employee must be prohibited from making elective deferral contributions for six months after receipt of a hardship distribution.

The elimination of the six-month suspension of elective deferrals may be applied on the first day of the first plan year beginning after December 31, 2018, even if a hardship distribution was made in the prior plan year. For example, a calendar year plan that provides for hardship distributions under the pre-2019 safe harbor standards may be amended to provide that the suspension period will end on January 1, 2019.

The Regulations further provide that for any distribution made on or after January 1, 2020, a plan may not provide for a suspension of contributions as a condition of obtaining a hardship distribution. In other words, the elimination of the six-month suspension of employee contributions is required after 2019.

Note that this required elimination does not apply to Code Section 409A nonqualified deferred compensation plans. Section 409A plans may eliminate any suspension periods, so long as doing so does not disqualify the plan under 409A.

C. Elimination of Loan Requirement

The Regulations eliminated the requirement that a participant must take all available loans under a plan in order to qualify for a hardship distribution. 

The elimination of the plan loan requirement is effective for hardship distributions made in plan years beginning after December 31, 2018. Unlike the elimination of the six-month suspension period, the elimination of the plan loan requirement is not mandatory. Plans may therefore continue to require that participants take all available plan loans in order to qualify for a hardship distribution.

D. Expanded Sources for Hardship Distributions

The Regulations provide that a 401(k) plan sponsor may, but is not required to, expand the sources that are available for hardship distributions to include qualified non-elective contributions (“QNECs”), qualified matching contributions (“QMACs”), employer safe harbor contributions and earnings on those contributions, as well as earnings on elective deferral contributions.

E. Reliance on Participant Representation

The Regulations provide that, with regard to hardship distributions made on or after January 1, 2020, a plan participant must represent in writing, by an electronic medium, or in such other form as may be dictated by the IRS, that he or she has insufficient cash or other liquid assets to satisfy the immediate and heavy financial need. A plan administrator may rely on the employee’s representation, unless the plan administrator has actual knowledge to the contrary. Assets that are allocated for a specific expense, such as rent, are not “available” to the Participant and cannot be considered in this analysis.

F. Application to 403(b) Plans

The Regulations clarify that the new rules, described above, generally apply to hardship distributions under 403(b) plans, with the exception of the new rules relating to the expanded sources of hardship distributions. Earnings on elective deferrals made to a 403(b) plan would continue to be ineligible sources for hardship distributions. However, QNECs and QMACs in a 403(b) plan that are not held in a custodial account could be distributed on account of hardship. QNECs and QMACs in a 403(b) plan that are held in a custodial account could not be distributed on account of hardship.

G. Timing of Plan Amendments

With regard to discretionary changes to individually designed plans, the plan amendment deadline is the end of the plan year in which the plan amendment is operationally put into effect. For example, if a calendar year plan operationally implements any discretionary provision of the Regulations in 2019, the plan would need to be amended on or before December 31, 2019 to reflect that provision.

The deadline for amending the plan to reflect a change in qualification requirements is the end of the second calendar year that begins after IRS issues the Required Amendments List that includes the change. For the 401(k) plan changes above, amendments should be adopted by December 31, 2021. For 403(b) plans, amendments reflecting the changes from these Regulations should be adopted by March 31, 2020.

If you currently use one of Foster Swift’s plan documents, we are in the process of updating our documents and will be contacting clients soon to assist in making the proper amendments. If you have any questions regarding these changes, or if you would like assistance with reviewing or amending your plan to incorporate any of these changes, please contact Mindi Johnson at (616) 726-2252 or Julie Hamlet at (616) 796-2515.