Easing Hardship Distribution Rules

The Bipartisan Budget Act of 2018 (the “Act”), recently passed by Congress, relaxes the rules for hardship withdrawals from tax-qualified 401(k) and 403(b) retirement plans for plan years beginning after December 31, 2018. Currently, taxpayers are prohibited from making pretax contributions for six months following the receipt of a hardship withdrawal from a qualified retirement plan. The Act lifts the six-month suspension, allowing taxpayers to continue making pre-tax contributions to their retirement plans.

The current hardship withdrawal rules state that the taxpayer must first exhaust all available financial resources to qualify for a hardship distribution. If any of the employer’s retirement plans allow for participant loans, the taxpayer must borrow from a plan, unless it would cause further hardship. The Act allows taxpayers to take a hardship withdrawal without first taking a retirement plan loan.

The existing hardship withdrawal provisions limit the sources available for distribution to pre-tax deferrals (excluding certain earnings) and employer profit sharing contributions. The Act expands the sources available to include (i) Qualified Non-Elective Contributions (QNECs), (ii) Qualified Matching Contributions (QMACs), (iii) Safe Harbor Contributions and, (iv) earnings on pre-tax deferrals, as well as earnings on all other sources.

The reasons for a hardship withdrawal have not changed under the Act. A participant can only take a hardship withdrawal under the following circumstances:

  • Expenses for medical care that would be deductible under Code section 213(d) for the employee, or the employee’s spouse, children, or dependents.
  • Costs directly related to the purchase of a principal residence (not including mortgage payments).
  • Payment of tuition, related education fees, and room and board expenses, for up to the 12 months of postsecondary education for the employee, or the employee’s spouse, children, or dependents.
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage.
  • Payments for burial or funeral expenses for the employee, or the employee’s spouse, children, or dependents.
  • Expenses for the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under Code section 165.

A hardship withdrawal is for an immediate and heavy financial need, and it must be limited to the amount necessary to satisfy that financial need. For example, if the taxpayer ha s $20,000 in accounts that are available for a hardship withdrawal but the maximum medical expenses eligible for deduction purposes is $5,000, the amount eligible for a hardship withdrawal is $5,000.

The taxpayer must agree to preserve the supporting source documents and make them available at any time, upon request, to the employer.

Although the rules are being relaxed, hardship withdrawals will remain a complex area of retirement plan administration.

If you have questions or would like more information, please contact Joel Leonor at jleonor@windes.com or 844.4WINDES.

Learn more about our Employee Benefit Services practice