Overview


The IRS recently issued proposed amendments to regulations concerning 401(k) plan hardship distributions. The proposed regulations address changes to hardship distribution rules from the Bipartisan Budget Act of 2018 and other legislation.

Though the regulations are only proposed, 401(k) plan sponsors should promptly consider these changes because decisions should be made on applying certain optional changes, which generally can be effective for plan years beginning after December 31, 2018.

In Depth


The Internal Revenue Service (IRS) has issued proposed amendments to the regulations governing hardship distributions under 401(k) plans. The proposed regulations mainly address changes made to the hardship distribution rules by the Bipartisan Budget Act of 2018 (Budget Act). The proposed regulations also address hardship distribution topics arising from other legislation.

Although the regulations are only proposed and comments are requested, 401(k) plan sponsors should consider the changes promptly because decisions should be made on applying the optional changes, which generally can be effective for plan years beginning after December 31, 2018. Because the changes simplify administration of hardship withdrawals, many 401(k) plans will likely start to apply the changes as of January 1, 2019. The proposed regulations generally apply to 403(b) plans, but subject to the differences described under “Other Changes Addressed in Proposed Regulations.”

Background

If a participant experiences a financial hardship as described in IRS regulations, a 401(k) plan may allow the participant to receive a distribution from the 401(k) contributions credited to the participant’s plan account. Hardship distributions are only available to satisfy an immediate and heavy financial need, and only to the extent of the need. Most 401(k) plans follow safe harbors in the 401(k) regulations to determine whether there is a need and the amount necessary to satisfy the need.

Principal Budget Act Changes to the Hardship Distribution Rules

The Budget Act made the following changes to relax the safe harbor requirements for hardship distributions, and to expand the amounts available for hardship distributions:

  • Eliminated the requirement that a participant’s contributions to the 401(k) plan and all other employer plans be suspended for at least 6 months following the receipt of a hardship distribution;
  • Eliminated the requirement that a participant take all available loans from the 401(k) plan and all other employer plans before receiving a hardship distribution; and
  • Allowed hardship distributions from these sources in addition to 401(k) contributions: qualified non-elective contributions (QNECs), qualified matching contributions (QMACs), employer safe harbor contributions and earnings on those contributions as well as earnings on 401(k) contributions.

Proposed Regulations Address Unanswered Questions about Impact of Budget Act Changes on Hardship Distributions

The Budget Act did not address implementation of these changes and the proposed regulations provide welcome guidance, as follows:

  • A 401(k) plan (including a safe harbor plan) may continue to apply a 6-month suspension for any hardship distribution received prior to January 1, 2020, but not for a hardship distribution received on or after that date. Alternatively, a plan may eliminate the 6-month suspension as of the first day of any plan year beginning after December 31, 2018, even if the distribution was made earlier.
  • For plan years beginning after December 31, 2018, a 401(k) plan need not require that a participant take all available loans from the plan and other employer plans before receiving a hardship distribution.
  • For plan years beginning after December 31, 2018, a 401(k) plan may (but need not) expand the sources available for hardship distributions to include QNECs, QMACs and earnings on those amounts, together with earnings on 401(k) contributions. Also available for hardship withdrawal are employer safe harbor contributions to a 401(k) plan and earnings on those contributions.

Proposed Regulations Clarify Impact of Tax Cuts and Jobs Act Changes on Hardship Distributions

Unlike the Budget Act, the Tax Cuts and Jobs Act (Tax Act) did not directly address hardship distributions. However, the Tax Act narrowed the circumstances under which taxpayers are eligible for a casualty loss deduction, creating uncertainty whether hardship distributions would be allowed for casualty losses other than for federally declared disasters.

The proposed regulations clarify that the new, more limited definition of casualty loss under the Tax Act does not apply for purposes of determining whether a participant has an immediate and heavy financial need.

Other Changes Addressed in Proposed Regulations

The proposed regulations also address the following:

  • The safe harbor list of financial needs that justify hardship withdrawals expands to include a new category: expenses incurred as result of certain federally declared disasters. That change can start to apply as early as January 1, 2018.
  • Under the Pension Protection Act of 2006, certain expenses (educational, medical or funeral) of a participant’s primary beneficiary are included in the safe harbor list of financial needs.
  • Under the Heroes Earnings Assistance and Tax Relief Act of 2008, a 6-month suspension is required after certain distributions to individuals serving in the armed forces; under the proposed regulations, a 401(k) plan may (but need not) continue to apply that suspension.
  • To simplify administration of hardship withdrawals, a new general standard starts to apply for distributions on and after January 1, 2020; under this standard, a participant must represent that he or she has insufficient cash or other liquid assets to satisfy the financial need, and this representation can be relied on absent actual notice to the contrary.
  • The proposed regulations also apply to 403(b) plans, except that earnings on elective deferrals cannot be part of a hardship distribution, and QNECs and QMACs can only be distributed because of hardship if the 403(b) plan is not in a custodial account.

Next Steps

Plan sponsors should review the proposed regulations and decide how plans will be administered in light of the changes. There may be additional changes in the final regulations. Most plans will need to be amended for compliance with the regulations, with the final amendment deadline to be determined later by the IRS.