The Bipartisan Budget Act of 2018 (BBA) contained provisions to change the hardship distribution rules so participants can have better access to their money and allow them to continue to save for retirement. In late September 2019, the Internal Revenue Service issued its final hardship distribution regulations. There were very few changes between the proposed regulations published late last year and the recently published final regulations. Below are the hardship distribution rules based on the final regulations.
- Uniform standard for determining financial necessity and participant representation requirement. Plans must apply a uniform standard for determining whether the hardship is necessary to meet any financial need. The participant must first take all distributions available to them under the plan or any other plan sponsored by their employer, including dividend withdrawals under an employee stock ownership plan (ESOP). Also, the participant must provide representation that he or she has insufficient cash or other liquid assets reasonably available to satisfy the financial need. To determine if cash or assets are reasonably unavailable, the IRS clarifies that money earmarked for expenses in the near future would not need to be considered, e.g. rent. The representation may be in writing or by an electronic medium such as a recordkeeper’s website, or other forms acceptable to the IRS. The employer does not need to investigate the representation but If the employer has knowledge contrary to the participant’s representation, the hardship distribution should not be made. This rule is effective for hardship distributions made on or after January 1, 2020, however employers could apply it for plan years in 2019.
- Participants no longer required to take a loan before receiving a hardship distribution. Under the prior hardship rules, if the plan allowed for participant loans and there was a loan available to the participant, the participant had to take a loan before taking a hardship distribution. Now a participant can take a hardship distribution without taking the loan first. Employers may still require that a participant first take a loan before taking a hardship distribution, however we don’t believe this will be a common requirement for most employers. This rule is effective for hardship distributions made on or after January 1, 2020, however employers could apply it for plan years in 2019.
- Elimination of the 6-month deferral suspension. Under prior hardship rules, employees could not continue to defer money into the plan for six months after they took hardship distributions. Under the new law, this restriction has been removed and participants may continue to defer into the plan after they take hardship distributions. Plan sponsors do not have a choice on this particular provision, and they must stop suspensions for hardship distributions made on or after January 1, 2020. The suspension could also have been eliminated for plan years in 2019 as well. For plans eliminating the suspension as of January 1, 2020, suspensions may continue for hardship distributions taken out in the latter part of 2019 up until the 6-month expiration date; or alternatively the suspension could be lifted as of January 1, 2020.
- Clarification of the casualty loss safe harbor event and adds a new safe harbor hardship distribution event. Most plans follow the safe harbor rules and only allow hardships for particular circumstances. These reasons include prevention of a foreclosure of a principal residence, medical expenses, etc. The IRS has clarified that casualty losses for hardships are not tied to a federal disaster, so we revert to the prior rules for casualty losses. Also, the BBA law included another safe harbor event which allows a hardship for expenses and losses (including loss of income) incurred by the employee on account of a disaster declared by FEMA, provided that the employee’s principal residence or principal place of employment at the time of the disaster was located in an area designated by FEMA for individual assistance with respect to the disaster. This rule is effective for hardship distributions made on or after January 1, 2020, however employers could apply it for plan years as far back as 2018.
- Expands the type of money that participants can receive as a hardship in a 401(k) and 403(b) annuity contracts. The current hardship rules restrict the type of accounts that participants can take money out of for hardship distributions. Under the new BBA law, participants will be able to take hardship distributions from all accounts including:
- Deferrals, vested matching and other employer contributions
- Safe harbor contribution accounts
- Qualified Nonelective Contributions (QNEC)
- Qualified Matching Contributions (QMAC)
- Earnings for all eligible sources including post 12/31/1988 earnings on elective deferrals. Note: This is not allowable for 403(b) plans yet.
Important Note: 403(b) plans that are in custodial accounts cannot allow hardship distribution from these additional contribution sources. Participants in custodial 403(b) plans cannot take hardship withdrawals from safe harbor, QNEC, QMAC accounts, or from post-1988 earnings in deferral accounts.
This rule is effective for hardship distributions made on or after January 1, 2020, however employers could apply it for plan years in 2019.
Plan documents will need to be amended to incorporate the new hardship rules. The IRS guidance on the timing of the amendments has been confusing. For 401(k) plans, the IRS clarified the deadline a bit better in the final regulations, but further guidance is welcomed. We believe the deadline for amending 401(k) plans is no later than the due date of the employer’s 2020 tax return (plus extensions), even though some of the provisions may have been effective in the 2019 plan year. At this time, it is not clear when 403(b) plan documents must be updated. However, it is probably best to amend the plan on or before the next remedial amendment period for the 403(b) plans, which is March 31, 2020. The IRS may delay these deadlines, so we will keep an eye out for any additional guidance.
Plan Sponsor Action
Plan sponsors should speak with their third-party administrator/recordkeepers about the new rules to ensure that the required changes are made for hardship distributions taken on or after January 1, 2020.
TRI-AD had already incorporated most of these new rules into our operations in 2019 so that hardships were more available to 401(k) and 403(b) participants. For 2020, TRI-AD will obtain the required participant representation to substantiate the financial need and will soon prepare the necessary amendments for our clients’ plans.
Please contact your TRI-AD Client Service Manager if you have questions.