Final Rules for Hardship Distribution for Qualified Retirement Plans Issued by IRS
November 8, 2019
By Anthony Kaylin, courtesy of SBAM Approved Partner ASE
On November 9, 2018, the IRS published proposed rules to change the requirements for hardship distributions from a 401(k) or 403(b) retirement plan. These rules grew out of the Bipartisan Budget Act of 2018, which opened the door for easing the rules governing hardship withdrawals from these plans. On September 23, 2019 the IRS published final rules governing hardship distributions.
A hardship withdrawal is one that is required by an employee to satisfy an immediate and heavy financial need if (i) the employee has obtained all other currently available distributions and loans under the plan and all other plans maintained by the employer and (ii) the employee is prohibited from making elective contributions to the plan and all other plans maintained by the employer for at least six months after receipt of the hardship distribution. A hardship withdrawal then will allow an employee to withdraw the elective contributions (excluding earnings) if all conditions are met.
The proposed rules clarified the meaning of “deemed immediate and heavy financial need;” the imposed restrictions and the required distributions necessary to satisfy financial need; and the resources available to use as hardship distributions. First, the list of those who can access a hardship withdrawal expanded the definition of primary beneficiaries to spouses and dependents (for whom qualifying medical, educational, and funeral expenses may be incurred). Second, the proposed rules made it easier to obtain a hardship distribution by eliminating the six-month mandatory suspension from making elective deferrals to retirement plans after receiving a hardship distribution and not requiring participant to previously take a plan loan if available.
Finally, the proposed rules modified the test to determine whether a hardship withdrawal is allowed based on the following factors: the funds requested do not exceed the need, all other available distributions under the plan were requested and obtained, and the participant did not have sufficient cash or other liquid assets to satisfy the need.
The final regulations maintained the proposed rules but clarified the prohibition of the six-month rule by stating that it applies to qualified plans, 403(b) plans, and eligible 457(b) plans but does not apply to unfunded, nonqualified, deferred compensation plans subject to Section 409A of the Internal Revenue Code.
Next, the hardship distribution may not exceed the amount of the participant’s need (including any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution). Second, a participant only has the option (but is not required) to take non-hardship distributions before requesting a hardship withdrawal under the employer’s plans. Finally, the employee must represent in writing or by an electronic medium that he or she has insufficient cash or other liquid assets available to satisfy the financial need. The plan administrator may rely on the representation unless he or she possesses actual knowledge to the contrary.
The final rules will apply to all hardship distributions made on or after January 1, 2020. However, any plan modified during 2019 may allow the new hardship rules to be applicable as of January 1, 2019. Otherwise, sponsors of qualified plans will be required to amend their plans to reflect the final regulations by the end of the second calendar year that begins after the new regulations promulgated or December 31, 2021. However, the amendment deadline for 403(b) plans is March 31, 2020, but the government has indicated they are considering providing for a later amendment deadline. Any such delay will be issued in separate guidance.