Retirement plans can offer a few options regarding early access to saved funds. Under many employer-sponsored retirement accounts, plan participants may have been offered two early distribution options. One was under a hardship qualification and the other, if allowed, was a loan against the amounts they had vested in the plan. It’s important to understand what hardship distributions and loans are and how the funds may be used.
- Hardship Distributions – plan participants can withdraw their vested funds because of specifically identified financial circumstances (e.g. health care expenses). The amount withdrawn can only be enough to cover the amount of the hardship plus any taxes or penalties imposed and is not required to be paid back into the account.
- Loans – plan participants can withdraw up to 50 percent of the amount of funds they had vested up to a maximum of $50,000. However, the funds would have to be repaid to the plan within a period of five years (longer if for a home purchase) and payments must be made at least quarterly.
In November 2018, the Internal Revenue Service (IRS) proposed new regulations concerning hardship distributions in retirement plans, including 401(k) and 403(b) accounts. This new guidance is seen as especially helpful as employers have the ability to include hardship provisions but had little guidance for determining if a hardship existed.
Covered Expenses for Hardship Distributions
All hardship withdrawals from a 401(k) or 403(b) plan were restricted to what the IRS termed an “immediate and heavy financial need”. These needs included:
- avoiding a foreclosure or eviction on the plan participant’s primary residence
- education expenses for the spouse or child of a participant or the participant, if such expenses were for post-secondary education and had to be paid within a year
- expenses for medical care for which the participant had no insurance
- funeral expenses for participant or participant’s spouse, children, dependents or beneficiaries
Withdrawals were also allowed if the plan participant had suffered damage to their primary residence which they had no other way to pay, and in the event the participant was purchasing a new home intended as a primary residence. It is also worth noting that if a plan participant did take a hardship withdrawal, they would be unable to make any new contributions to the plan for a period of six months. Finally, a participant had to show the plan administrator there was a financial need by providing backup documentation. If a plan participant had not exhausted allowed plan loans, they would be ineligible for a hardship withdrawal.
Proposed Changes to Hardship Withdrawals
Under the new rules, a plan sponsor can accept a written statement from the participant where they certify there is a financial need. This reduces the paperwork burden that is required before a hardship withdrawal is complete. However, there are other changes which are important as well:
- No Plan Loan Requirement – although it is not mandatory, the requirement for the participant to exhaust any allowed plan loans before taking a hardship withdrawal can be eliminated. The plan may retain this requirement on a discretionary basis.
- Allow for Further Contributions – while a plan administrator has until 2020 to implement, plan sponsors can no longer prohibit contributions following a hardship withdrawal. This mandatory rule is effective January 1, 2020 but can be applied earlier.
- Investment Earnings Distribution – specific to 401(k) plans, distributions may now include investment earnings on the participant’s savings for hardship withdrawals. However, 403(b) plans still prohibit investment earnings to be counted for hardship withdrawals.
- New Category for Hardship – if a participant lives in an area which is declared a federal disaster by the Federal Emergency Management Agency (FEMA), they can take a hardship withdrawal.
- Notification Deadlines – plan administrators will also have deadlines for notifying plan participants who request a loan or withdrawal which is currently not required.
Plan Sponsor Actions
In order to comply with the changes, plan administrators will have to review, and where needed, modify their plan documents to reflect the changes to hardship distribution provisions. While some changes will have to be modified immediately, administrators will be given a fair amount of time once the IRS has determined these rules are to be enforced.
Plan sponsors are strongly encouraged to review their plan documents and the proposed regulations so they are prepared to make the necessary changes in a timely manner. Those who are uncertain as to how best to proceed should consider contacting an independent Registered Investment Advisor, such as PlanPILOT for help. We can help you be better prepared for these changes and ensure a seamless integration of the new rules for your plan. Contact us today at (312) 973-4911 or email info@planpilot.com.
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