The Treasury Department has issued proposed hardship distribution regulations that incorporate changes made in the Bipartisan Budget Act, the Pension Protection Act of 2006, and the Tax Cuts and Jobs Act. The Treasury Department has also provided guidance on the applicability of the 401(k) hardship withdrawal changes to 403(b) plans. The proposed regulations will be published in the federal registrar on November 14, 2018, with a comment period running until approximately January 14, 2019.
The updated Treasury Regulations and the various statutory changes revise both the hardship distribution rules and the safe harbor hardship distribution rules:
General Hardship Distribution Changes
More Sources: Allow hardship withdrawals from qualified nonelective contributions and qualified matching contributions (although a plan is not required to allow hardship withdrawals from these sources), as well as investment earnings on these sources and elective contributions.
Distribution Necessary Test: Changed the test to determine whether a distribution is necessary to satisfy an immediate and heavy financial need to a three-part test:
- The hardship distribution may not exceed the amount needed to satisfy the immediate and heavy financial need.
- The employee must have obtained all other distributions available under the employer’s plan and all other qualified or nonqualified plans maintained by that employer.
- The employee must represent in writing, by electronic means or otherwise, that the employee has insufficient cash or other liquid assets to satisfy the need (the third prong is effective as of January 1, 2020). (This representation cannot be relied on if the plan administrator has actual knowledge to the contrary.)
Safe Harbor Hardship Distribution Changes
1) Immediate and Heavy Financial Need Safe Harbor (List of Safe Harbor Expenses)
- Damage to Principal Residence: Updated the safe harbor list of hardship withdrawal expenses so that a participant requesting a hardship withdrawal due to damage to a principal residence that qualifies for the casualty deduction under Code § 165 does not need to satisfy the casualty loss deduction requirement that the loss is attributable to a federally declared disaster. This update can be applied retroactively to any hardship withdrawals that were taken on or after January 1, 2018.
- Primary Beneficiary: Updated the safe harbor list of hardship withdrawal expenses to include a participant’s primary beneficiary as a person for whom they can request a hardship to pay medical, qualifying education or funeral expenses. This update aligns the Treasury Regulations with the Pension Protection Act of 2006’s requirement.
- Federally Declared Disasters: Added a new safe harbor hardship withdrawal expense so that participants can request a hardship for expenses and losses incurred because of a disaster as declared by the Federal Emergency Management Agency if their principal residence or principal place of employment is within the disaster area. This update can be applied retroactively to any hardship withdrawals that were taken on or after January 1, 2018.
2) Deemed Necessary to Satisfy an Immediate and Heavy Financial Need
- Deemed Necessary: The deemed “necessary” safe harbor has been deleted and now all hardship distributions must use the Distribution Necessary Test described above (whether or not safe harbor for purposes of determining immediate and heavy financial need). This eliminates the existing hardship distribution safe harbor requirements as follows:
- Six-Month Suspension: Removed the six-month suspension requirement for hardship distributions that are made on or after January 1, 2020, but plans can elect to apply this change as of the first day of a plan year after December 31, 2018.
- Non-taxable Loans: Removed the safe harbor requirement that a participant receive all available nontaxable loans from a plan prior to receipt of a hardship distribution, but plans can keep this condition at their election. Thus, a plan has the option as to whether participants requesting a hardship distribution must first take all nontaxable loans. The requirement that participants take a nontaxable loan is removed as of the first day of the plan year following December 31, 2018, a plan can keep this as an optional condition.
Impact on 403(b)
In addition, the Treasury Department analyzed the impact of the new 401(k) hardship withdrawal rules on 403(b) plans and determined that the new regulations would generally apply. However, the Treasury Department noted that earnings on 403(b) elective deferrals are not an eligible source of hardship distributions and only qualified nonelective contributions and qualified matching contributions held in a 403(b) plan that are not in a mutual fund custodial account may be distributed because of hardship.
Plan sponsors should review their plans to determine whether a plan amendment is needed and what potential changes may be needed for existing administrative practices. Plan sponsors should ask:
- Does my plan need to be amended to reflect the updated hardship rules? These rules are still proposed, but plan sponsors may want to amend their plans earlier to document how they will implement changes.
- Do my plan’s existing administrative practices align with the new hardship rules?
- Does the employer want to remove the six-month suspension for the plan year beginning in 2019? Note, any suspension of deferrals following a hardship distribution must be removed from all plans by January 1, 2020.
- Does the employer want to continue requiring participants to take available nontaxable loans?
- Should the plan allow hardship distributions from the expanded sources? If so, which ones?
- Do we want to limit the reasons for hardship distributions to the safe harbor expenses only?