July 11, 2018

Safe Harbor Hardship Distributions Cannot Be Taken for Repayment of Student Loans

By Karen E. Gelula and Betsy A. Olson

In Information Letter 2018-1, the IRS responded to a U.S. Congressman who asked why his constituent could not take a hardship distribution from his 401(k) plan to pay off his daughter’s college student loans. The IRS explained that a hardship distribution must, among other things, be necessary to satisfy an immediate and heavy financial need. The Letter does not address the plan provisions applicable to the constituent but notes that under the safe harbor standards for hardship distributions in the Internal Revenue Code §401(k) regulations, education expenses are deemed a sufficiently immediate and heavy financial need if they are for the “payment of tuition, related educational fees, and room and board expenses, for up to the next 12 months of post-secondary education.”

The IRS confirmed in the Letter that because a safe harbor hardship distribution may be made only for the prospective payment of education expenses, it cannot be made for the repayment of student loans. The IRS suggested that as an alternative to taking a hardship distribution, the participant may be able to get a loan from the plan.

Note: 401(k) plans that permit non-safe harbor hardship distributions as described in the Internal Revenue Code §401(k) regulations could approve a participant’s hardship distribution request for the repayment of student loans, provided that the loan repayment constitutes an immediate and heavy financial need based on all the relevant facts and circumstances. Among other things, this includes the participant’s representation that the need cannot be relieved from other reasonably available resources such as insurance reimbursement, liquidation of the participant's assets, cessation of plan contributions, other currently available distributions such as ESOP dividends and nontaxable (at the time of the loan) plan loans, or borrowing from commercial sources.

As a reminder, the hardship distribution provisions will be changing in 2019, including the removal of the requirement in the safe harbor hardship distribution standards that a participant take all available plan loans to demonstrate financial necessity. In addition, the Treasury Secretary has been directed to remove from the safe harbor hardship distribution standards the requirement that the participant’s deferral contributions to all plans maintained by the employer must be suspended for six months following the withdrawal.

The Letter is available here.

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