Do You See What I See? Hardship Withdrawal Guidance From the IRS, As Requested by Congress

Published: December 26, 2018

This time of year, gift-givers may feel rich in spirit but otherwise penniless. They may ask whether they can receive a hardship distribution from their 401(k) account when faced with a not-so-holly or jolly bank statement at the end of December. Those of us who work with 401(k) plans know, however, that it takes more than a large credit card bill to justify a participant’s request for a hardship distribution. Generally, the federal tax code restricts a participant’s access to a 401(k) account balance so that such benefits can provide retirement income, not replenishment of a checking account. More specifically, federal tax rules permit a hardship distribution only if (a) the participant experiences an “immediate and heavy financial need” and (b) the distribution is no greater than the amount “necessary to satisfy the financial need.” In turn, Treasury regulations provide that hardship withdrawals on 401 (k) balances are available for participants who satisfy any of 6 safe harbors or a general, catch-all provision.

Additional requirements have historically applied. In order to be eligible for a hardship distribution, a participant, also, was required to have taken out all available plan loans, and after a hardship distribution was granted, the participant could not make 401(k) salary deferral contributions for six months afterwards. Although these rules sought to ensure that a hardship withdrawal was a distribution of last resort, some felt that they were unduly restrictive. For instance, an argument can be made that, by requiring a participant first to take out plan loans and to sit out of 401(k) contributions for six months, the rules interfered with participants rebuilding their account balance – thus worsening the very ills the rules sought to prevent. Over the summer, Congress responded to these concerns in the Bipartisan Budget Act of the 2018 (“2018 Act”), and as discussed in a previous blog post, changed some of those rules. On November 14, 2018, the IRS issued proposed regulations reflecting the changes made in the 2018 Act. Although the regulations will not be finalized until 2019 at the earliest, some of the new rules can be implemented earlier than that. Read on for details as to what – and when – changes are required and/or permissible as stated in the proposed regulations.

Optional for Hardship Distributions Made as Early as January 1, 2018; Otherwise, Generally Applicable for the First Plan Year Beginning after December 31, 2018:

Permitted for the First Plan Year Beginning after December 31, 2018 (Even for Distributions in 2018); Mandatory for Hardship Distributions Made on or after January 1, 2020:

Permitted Beginning with Hardship Distributions Made in the First Plan Year Beginning after December 31, 2018:

Effective for hardship distributions made on or after January 1, 2020, the participant will be required to represent in writing that he or she has insufficient cash or other liquid assets to satisfy the financial need. The plan administrator will be able to rely on the participant’s written representation so long as the plan administrator does not have actual knowledge to the contrary.

Changes to Plan Documents

The proposed regulations note that plan amendments will be necessary to reflect these changes once final regulations are issued, but states that such amendments will have a deadline that is tied to the Required Amendments List published by the IRS. In other words, the IRS notes in its preamble that the normal rule for determining the deadline for a disqualifying provision applies. Therefore, it is expected that an individually designed plan will be considered timely amended so long as the plan is amended no later than the end of the second calendar year that begins after issuance of the Required Amendments List that includes these changes.

Changes in Plan Administration

When it comes to plan administration, time is of the essence. Plan sponsors should review their hardship distribution procedures and identify the appropriate effective date for the changes that are mandatory, as well as the optional changes they wish to implement. Plan administrators must evaluate how their hardship distribution forms, participant communications, and operational procedures must be revised to implement such changes, and then accomplish those changes on time. A plan sponsor whose plan is on a pre-approved platform (previously referred to as “prototype” or “volume submitter” documents) should talk with their document provider to understand what options are available to them and choose accordingly.

If you have questions about how these changes apply to your plan, or how to comply with these changes, contact experienced benefits counsel who can review your plan terms with you. 

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