On November 14, 2018, the IRS released the eagerly-awaited proposed regulations regarding hardship distributions impacting section 401(k) and 403(b) plans (the “Proposed Regs”). The Proposed Regs address many hardship distribution issues, including those raised by both the Bipartisan Budget Act of 2018 (the “Budget Act”) and the 2018 Tax Cuts and Jobs Act (the “Tax Act”).
Q: When is an amendment required to the plan documents?
A: The Proposed Regs state, “…if these regulations are finalized as they have been proposed, plan sponsors will need to amend their plans’ hardship distribution provisions.” The Proposed Regs also state that all provisions of the final regulations will have the same amendment deadline. It appears plan sponsors may rely on the Proposed Regs in operation prior to the plan being amended. Although the Proposed Regs discuss timing of the amendments for individually designed plans, they are silent regarding amendments for pre-approved plans. As such, it is unclear on the deadline for amending plan documents. If or when the IRS provides additional information on amendments, we will send you an additional correspondence.
Q: How should the 6-month suspension period for hardship distributions be handled on January 1, 2019?
A: The Proposed Regs give the plan sponsor discretion in handling the suspension period for hardship distributions taken in the second half of 2018 as well as hardship distributions taken in 2019. The plan sponsor may continue to enforce the suspension or allow contributions to resume sooner (e.g., January 1, 2019). The Proposed Regs prohibit the use of the 6-month suspension for hardship distributions occurring on or after January 1, 2020.
Q: So no more 6-month suspension period for any distributions?
A: There is still a 6-month suspension period on elective deferrals for qualified reservist distributions, if allowed under the plan. This restriction was added by the HEART Act and the Proposed Regs clarify that there is still a permissible restriction on elective deferrals after qualified reservist distributions.
Q: What sources of money are available for hardship distributions for 401(k) plans?
A: All sources of money in a 401(k) plan are now available. The Proposed Regs confirmed the addition of safe harbor contributions under both traditional and qualified automatic contribution arrangements (QACAs), qualified non-elective contributions (QNECs), qualified matching contributions (QMACs), and earnings on all of the above as well as earnings on elective deferrals credited after 1988.
Q: Are plan sponsors required to allow hardship distributions from these 401(k) sources?
A: No. The plan sponsor is permitted to restrict the sources of money available for hardship distributions. This restriction may include the additional sources available under the Proposed Regs or sources already available (e.g., matching contributions).
Q: What about 403(b) sources for hardship distributions?
A: The Proposed Regs do not change current regulations preventing hardship distributions from contributions other than elective deferrals held in a custodial account. On the other hand, the Proposed Regs now expand the availability of contributions held in non-custodial accounts similar to hardship distributions for 401(k) plans with one exception. Whether or not held in a custodial account, earnings on 403(b) elective deferrals continue to be unavailable for hardship distributions. The Proposed Regs explained that the failure to amend section 403(b)(11) in the Budget Act prevented the IRS from interpreting otherwise.
Q: Are available plan loans still required before permitting a hardship distribution?
A: No. A participant is not required to take an available loan under the plan before taking a hardship distribution, effective January 1, 2019. However, a plan sponsor has the discretion of requiring participants to take a loan before receiving a hardship distribution. Note that this change only impacted the requirement to obtain a loan prior to a hardship distribution; participants are still required to obtain other available distributions under the plan prior to obtaining a hardship distribution.
Q: Any other changes to determining eligibility for hardship distributions?
A: Yes. The Proposed Regs provide one general standard for determining whether a hardship is necessary to satisfy a financial need. This replaces the old facts and circumstances standard. Going forward, (1) a hardship distribution may not exceed the amount of an employee’s need; (2) the employee must first obtain other available distributions under the plan; and (3) the employee must represent that he or she has insufficient cash or other liquid assets to satisfy the financial need (representation may be relied upon by administrator unless actual knowledge to the contrary). The requirement to obtain the employee’s representation applies for distributions made on or after January 1, 2020.
Q: Any update on the Tax Act’s impact on the casualty loss safe harbor expense?
A: Yes. The Proposed Regs carve out the Tax Act’s requirement that a casualty loss deduction is attributable to a federally declared disaster. As such, the standard for safe harbor expense based on casualty loss returns to losses arising from fire, storm, shipwreck or other casualty. The Proposed Regs allow this previous standard to be applied to any hardship distribution on or after January 1, 2018, the Tax Act effective date.
Q: Any other changes to the safe harbor expenses?
A: Yes. The Proposed Regs add a new safe harbor for expenses or losses incurred in a federally declared disaster area if the employee’s principal residence or principal place of employment is located in the designated area at the time of the disaster. Also, in accordance with the Pension Protection Act of 2006, the Proposed Regs update the medical, educational and funeral safe harbor expenses to include the participant’s primary beneficiary in determining if a participant has incurred a hardship.