Special thanks to Victoria Hanohano-Hong, Porter Wright law clerk, for her assistance on this article.
The IRS recently published final regulations, which amend the hardship withdrawal rules for 401(k) and 403(b) plans. The regulations reflect statutory changes to 401(k) and 403(b) plans, including changes made by the Bipartisan Budget Act of 2018. Most of the changes are optional and do not require employer adoption; some are not optional. The following changes are mandatory for plans that allow hardship withdrawals and may require plan amendments (the deadlines for which are noted at the end of this post).
Remove six-month contribution suspension
Prior rules prohibited employee deferrals for six months following a hardship withdrawal. Congress removed this rule to encourage continued retirement savings. Now, employers will be prohibited from suspending employee contributions following a hardship withdrawal.
Employers must remove suspension language from plan documents by the applicable amendment deadline—likely Dec. 31, 2021, for individually designed plans (but this will depend on inclusion in the next IRS Required Amendments List). Employers must make the change operationally by Jan. 1, 2020, for any hardship distributions made on or after such date. Any ongoing suspensions that are currently in place may be voluntarily lifted before the 2020 deadline, but the regulatory language only applies the prohibition on suspension to hardship withdrawals taken on or after Jan. 1, 2020.
Add safe harbor category for disaster-related expenses and losses
Up to now, the IRS has made special disaster relief announcements that permitted hardship withdrawals to employees affected by federally-declared disasters. The growing frequency of major disasters, however, prompted the IRS to add a seventh safe harbor category for hardship withdrawals.
Employees may make hardship withdrawals for expenses and losses, including loss of income, due to federally-declared disasters. This new rule is narrower than prior announcements, which would have allowed employees to make withdrawals for such expenses and losses of relatives and dependents. To qualify, the employee’s primary residence or principal place of employment must be within a FEMA-designated area for individual assistance. For plans that utilize the Code’s safe harbor to determine whether a distribution is made on account of hardship, this provision would need to be added to the plan’s safe harbor list of expenses for which distributions are deemed to be made on account of an immediate and heavy financial need.
Add beneficiary as an individual for whom certain safe harbor expenses can be incurred.
The final regulations also codified a modification to the safe harbor list of expenses for which distributions are deemed to be made on account of an immediate and heavy financial need. The final regulations added a “primary beneficiary under the plan” as an individual for whom qualifying medical, educational and funeral expenses may be incurred. While not a new concept, this provision now appears in the hardship regulations.
Use new three-part test to determine if a withdrawal is necessary
Before, if an employee did not qualify for a safe harbor expense category, the employer had to consider all relevant facts and circumstances to determine if a requested hardship withdrawal was “necessary” to meet an immediate and heavy financial need. These laborious determinations are no longer required.
An employer may approve a hardship withdrawal if three requirements are met:
- The withdrawal amount does not exceed the employee’s need (including any amounts necessary to pay any applicable income taxes or penalties reasonably anticipated to result from the distribution, such as an early withdrawal penalty);
- The employee has received all available non-hardship distributions from the employer’s plans; and
- The employee attests to the employer that they have insufficient cash or other liquid assets reasonably available to satisfy the financial need.
- As to this item, the employee’s statement to the employer may be written or made through a recorded phone call. Unless the employer actually knows the statement is false, it may rely on the statement without investigating further.
- Employers should consider establishing a process to receive these statements.
Additional optional provisions:
Expansion of sources
Previously, the IRS expressly excluded earnings, qualified non-elective contributions (QNECs) and qualified matching contributions (QMACs) as sources available for hardship withdrawals. An employee could only draw from their elective deferrals and could not access either earnings on those deferrals, or the employer’s QNEC or QMAC contributions (which includes by definition any safe harbor contributions). That rule is no more.
At the employer’s election under the final regulations, 401(k) plans may permit hardship withdrawals from elective contributions, QNECs, QMACs and earnings on those amounts, regardless of when they were contributed or earned. The same is not true for 403(b) plans. Non-custodial 403(b) plans may only expand hardship withdrawal sources to QNECs and QMACs, but not to the earnings on those contributions, and custodial 403(b) plans are not allowed to expand their hardship withdrawal sources at all.
Although the IRS does not require employers to expand hardship withdrawal sources to include the noted contributions and earnings, it is an option worth considering. Plans may elect to expand sources operationally as early as Jan. 1, 2019.
Elimination of requirement to take plan loan
In addition, the final regulations retain the proposal that allows plan sponsors to remove the requirement that a participant first take any available plan loans prior to taking a hardship withdrawal from the plan. Previously, this was a condition of determining that a distribution was deemed necessary to satisfy the participant’s immediate and heavy financial need. This condition is no longer required, by a plan sponsor may elect to retain this as a condition to taking a hardship distribution.
As referenced above, amendments to individually-designed 401(k) plans will most likely be required by Dece. 31, 2021 (assuming inclusion in the 2019 IRS Required Amendments List). As it currently stands, any 403(b) plans must be amended by March 31, 2020. However, the IRS is considering extending the 403(b) plan deadline. Pre-approved plans must amend, if necessary, by their fiscal 2020 tax-filing deadline. Please note that if your plan is a pre-approved plan (a prototype plan, or a volume submitter plan), the document sponsor may handle some or all of these required amendments.