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Audit & Assurance, Employee Benefit Services

Final IRS Changes for Hardship Distribution Rules

Hardship distributions allow participants of retirement plans to remove funds from their accounts before reaching the age of 59½ to fulfill an immediate financial need. On September 23, 2019, the IRS announced the final changes to the rules that govern these distributions from 401(k) and 403(b) plans. This article contains a summary of the changes to the hardship distribution rules.

1.    Eliminating the 6-Month Suspension

As per the IRS, plan sponsors can choose to eliminate the six-month suspension period on employee contributions for hardship distributions for plans, as well as end any existing suspension periods applicable from the first day of their plan year, beginning after December 31, 2018. It also applies for a hardship distribution made in the previous plan year.

However, the IRS does not permit plan sponsors to suspend employee contributions concerning a hardship withdrawal made on or after January 1, 2020. It applies to all qualified plans, 403(b) plans, and governmental 457(b) plans. The prohibition on the suspension does not apply to any non-qualified deferred compensation plans subject to Code Section 409A.

2.    Eliminating the Requirement of Applying for Plan Loan First

Previously, the IRS required plan participants to apply for available plan loans before they could receive a distribution. Under the new hardship distribution rules, plan sponsors can eliminate or retain this requirement before receiving the distribution. The new rules apply to plans beginning after December 31, 2018. Furthermore, the plan requirement can apply to all plans that your employer maintains.

3.    Expanding the Amounts Eligible for Hardship Distributions

Under the new regulations, a 401(k)-plan sponsor can allow hardship withdrawals from accounts holding QNECs, QMACs, elective deferrals, QACA safe harbor contributions, traditional safe harbor contributions, and all earnings present in these accounts.

There is one exception that applies to the 403(b) plans. As per the IRS, there are limited amounts available for a hardship distribution under these plans. To begin with, the earnings you attribute to Section 403(b) elective deferrals are ineligible for hardship distributions.  Secondly, the QMACs and QNECs in a 403(b) plan that are in a 403(b)(7) custodial account are also ineligible for such distributions. Conversely, any QMACs and QNECs in a non-custodial 403(b) annuity plan are eligible for distribution.

4.    Permitting Withdrawals for Casualty Loss Expenses Not Related to a Disaster

Previously, plan sponsors could make a hardship withdrawal for managing a “casualty loss” as described under Code Section 165. However, the Tax Cuts and Jobs Act of 2017 introduced a change to this section. As per this change, the casualty loss should be a result of a federally declared disaster. The provision created a level of uncertainty regarding its impact on hardship distribution.

Under the new regulations, the IRS has clarified that the Tax Act change does not apply to hardship withdrawals. It means that a hardship withdrawal made to manage expenses for repairing damage to your primary residence does not need to be related to a federally declared disaster.

You can apply this limitation for withdrawals made between 2018 and 2019. However, for distributions made on or after January 1, 2020, the disaster limitation is no longer applicable.

5.    Introducing Disaster Events as a New Reason for Withdrawals

Previously, the IRS had allowed withdrawals for managing losses and expenses incurred due to a federally declared disaster.

Under the new regulations, plan participants can make withdrawals to manage immediate and heavy losses and expenses faced due to a disaster declared by FEMA (the Federal Emergency Management Agency). It requires that the location of the employee’s primary residence or place of employment be in an area FEMA designates eligible for individual assistance for a specific disaster.

However, it is also important to note that relief provided under this new reason is limited compared to the relief offered under prior disaster guidance, such as the Announcement 2017-15. It only permits distributions for the participant’s losses and expenses.

Nevertheless, the inclusion of this new reason still eliminates potential delays and uncertainties and helps participants access plan funds more easily after a federally declared disaster. This provision applies to distributions made on or after January 1, 2018.

6.    Elimination of the Catch-All “Facts and Circumstances” Test

Previously, plan participants could only make a withdrawal to satisfy a financial need per the catch-all “facts and circumstances” test. The proposed regulations eliminate this test for distributions made on or after January 1, 2020. Instead, any withdrawals must satisfy a general and more objective standard. The new standard requires that

  • the distribution amount should not exceed what the employee needs (this includes amounts required to pay local, state, or federal taxes and penalties applicable due to the distribution);
  • the employee should first obtain other distributions available under the 401(k) and 403(b) plan and all other qualified and unqualified plans offering deferred compensation that their employer maintains (including all currently available distributions like the available ESOP dividends); and
  • the employee should present via writing, an online application, or verbally through a recorded telephone conversation to having insufficient cash or liquid assets to meet a financial need. They can also use other methods of communication that the IRS prescribes for this purpose. The employee can also clarify that any available cash or liquid assets are for other expenses such as rent. As a result, they are not reasonably available to the employee.
What are the Next Steps?

Now that the IRS has issued the final regulations, we recommend plan sponsors and recordkeepers go over their hardship distribution procedures and adopt any amendments that reflect the changes introduced (both mandatory and optional changes). If you are utilizing a pre-approved plan document, we suggest checking with your plan provider about the action steps needed. It can allow you to be aware of any default provisions that the plan provider is introducing. Finally, for safe harbor plans, employers must ensure they have updated the safe harbor notice to reflect the hardship distribution rules in the case of safe harbor plans.

If you are interested in learning more about how the new rules influence your employee benefit plans, reach out to the team at Windes. We can help you update your current plans to ensure compliance with the new requirements and allow you to provide your employees with any needed financial assistance.


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