On November 14, 2018, the IRS issued much-awaited proposed regulations relating to hardship distributions from 401(k) plans. The new guidance implements changes to the 401(k) plan hardship distribution provisions that were adopted as part of the Tax Cuts and Jobs Act of 2017 (TCJA) and the Bipartisan Budget Act of 2018.
The new rules liberalize the 401(k) hardship distribution “safe harbor” requirements, making it easier for participants to obtain hardship distributions from their plan accounts. This issue of Tax Advisor Weekly will summarize the changes.
Under the prior safe harbor 401(k) hardship distribution rules, a participant who took a hardship distribution was required to have their salary deferral contributions to the plan suspended for six months. The new rules eliminate this requirement. Plan sponsors may optionally make this provision effective for hardship distributions made during plan years commencing after December 31, 2018 (January 1, 2019, for calendar year plans). The change is mandatory starting in 2020.
If a plan sponsor elects to make the new rule effective in 2019, then with respect to hardship distributions that were made in the second half of 2018, the plan sponsor may either lift the suspension effective January 1, 2019, or leave the suspension in place for the full six months.
If a plan sponsor elects to implement this change in 2019, a plan amendment would be required prior to the end of the plan year in which the change is effective (December 31, 2019, for calendar year plans).
Plan Loan Requirement
Under the prior rules, participants were ineligible for a hardship distribution unless they had first taken all available nontaxable loans under all plans within the employer’s controlled group. This requirement has been eliminated effective as of the first plan year commencing after December 31, 2018 (January 1, 2019, for calendar year plans). The change is optional, and plan sponsors may continue to enforce the plan loan requirement going forward. If the plan sponsor elects to eliminate this requirement in 2019 because the change is optional, calendar year plans must be amended no later than December 31, 2019, to implement the change.
Participant Representation Provision
Under prior law, the 6-month suspension and plan loan requirements were intended to establish that the amount of the hardship distribution was necessary to satisfy an immediate and heavy financial need. With the elimination of those requirements, the new regulations provide that this requirement is satisfied if (1) the amount of the distribution is not in excess of the amount required to satisfy the financial need (taking into account applicable taxes and penalties); (2) the participant has obtained all other currently available distributions under all plans maintained within the controlled group (excluding plan loans); and (3) the participant represents in writing (or by electronic means) that he or she has insufficient cash or other liquid assets to satisfy the financial need. The plan administrator is entitled to rely on the participant’s representation absent actual knowledge to the contrary.
The new provision is effective January 1, 2020, although plan sponsors may adopt the new standard as of January 1, 2019. If the plan sponsor does so, the plan, once again, must be amended by December 31, 2019.
The safe harbor hardship rules previously referenced the casualty loss rules of section 165(h). The TCJA amended section 165 to restrict its applicability only to federally declared disasters. This caused some confusion among 401(k) plan sponsors and administrators because the amendment to section 165 had the unintended result that casualty losses could not constitute a hardship if they were not caused by a federally declared disaster. The new regulations provide that a casualty loss need not be a federally declared disaster to support a hardship distribution, and this change may be applied retroactively to January 1, 2018. However, if this change was applied retroactively, then the plan sponsor would have been required to amend the plan no later than December 31, 2018. In the absence of a plan amendment, the plan sponsor may wish to utilize the IRS’s Voluntary Correction Program to correct the failure to timely amend the plan.
Expansion of Fund Sources
Under prior law, hardship distributions were only permitted from elective deferrals, excluding earnings. The new law expands the available sources of funds for hardship distributions, by including earnings on elective deferrals, as well as qualified nonelective and qualified matching contributions and earnings thereon. This change is optional, and thus, if implemented, the plan must be amended by the last day of the plan year in which implementation occurs.
Plan Amendment Requirements
As mentioned above, with respect to any change that is implemented on a discretionary basis (which would include optional changes as well as early adoption of otherwise mandatory changes), the plan amendment must be adopted no later than the end of the plan year in which the change is implemented.
For mandatory changes, plans must be amended by the end of the second plan year following the plan year in which the change is included on the Required Amendments List, which is published by the IRS near the end of each calendar year.
Alvarez & Marsal Taxand Says:
The new hardship distribution rules provide greater flexibility to allow participants access to their 401(k) accounts in the event of financial hardship. Plan sponsors should be aware, however, that early implementation of any mandatory changes, or implementation of discretionary changes, will require a plan amendment no later than the last day of the plan year in which a change becomes effective. We at Alvarez & Marsal are available to assist should you have any issues concerning the new rules, their implementation or required plan amendments.