On November 9, 2018, the IRS released proposed amendments to the hardship distribution regulations
applicable to 401(k) plans (“Proposed Regulations”) that permit such distributions.. These amendments reflect changes in the law under the Tax Cuts and Jobs Act of 2017 (“Tax Act”) and the Bipartisan Budget Act of 2018 (“Budget Act”).
Although it’s now possible to get some sense of the nature of the changes, most plan sponsors will wait until the final regulations are issued (sometime in 2019) before preparing formal amendments.
These changes are summarized as follows:
1. Allows plans to permit hardship distributions due to a casualty loss under the standard that applied prior to the Tax Act. Therefore, it is not necessary to meet the requirement under newly-added Code 165(h)(5) requiring the loss to be attributable to a federally declared disaster. This standard can be applied retroactively to casualty losses incurred during 2018.
2. Becomes automatic that a hardship distribution for those in FEMA-designated areas is permissible when there is a major federally declared disaster. There will no longer be a need to make interim amendments for each specific event.
3. The elimination of the 6-month suspension rule. No plan may impose a suspension period prohibiting an employee from making elective deferrals and after-tax employee contributions after receipt of a hardship distribution. At the option of the employer, this rule can become effective for the 2019 plan year. All plans must comply with this rule effective for the 2020 plan year. For hardship distributions issued during 2018, the plan may either continue to apply the current suspension or eliminate it as of the beginning of the 2019 plan year.
4. The requirement to seek a loan prior to a hardship distribution is eliminated.
5. A general standard is established for a plan administrator to determine whether a distribution is necessary to satisfy an employee’s financial need, as follows:
- A hardship distribution may not exceed the amount of an employee’s financial need
- The employee must have obtained other available distributions under the employer’s plan
- The employee must represent that he or she has insufficient cash or liquid assets to satisfy the financial need
- A plan administrator may rely on an employee’s “self-certification” unless the plan administrator has actual knowledge to the contrary
6. Expansion of sources for hardship distributions to include qualified nonelective contributions (QNEC), qualified matching contributions (QMAC) and employer safe harbor contribution sources. Allowing hardship distributions from these additional sources is discretionary, and a plan may restrict access to any particular source.
7. Earnings on sources for hardship distributions are allowed to be withdrawn.
8. Application to 403(b) plans. The proposed regulations generally apply to 403(b) plans with the following exceptions:
- Cannot distribute earnings on elective deferrals
- Hardship distributions from QNEC, QMAC and safe harbor contribution sources are limited to annuity contracts and do not apply to custodial accounts
As these are just proposed regulations, it is possible the final version will differ. The IRS expects plan sponsors will need to amend their plans’ hardship provisions if the proposed regulations become final. Given the required 60-day comment period before the proposed regulations become final, the earliest plan amendment deadline to conform to the final regulations would be December 31, 2020, for calendar year plans.