IRS Finalizes Hardship Distribution Regulations

Many employer-sponsored retirement accounts offered its plan participants under financial turmoil access to their 401(k) or 403(b) retirement funds through a process known as a hardship withdrawal. Historically, the need has been determined based on all relevant facts and circumstances. However, on September 23rd, just 10 months after releasing proposed regulations, the IRS released its final hardship distribution regulations making retirement plan assets more accessible to those experiencing financial hardship. We explore these changes and what they mean for plan sponsors and their participants.

Hardship Distribution Overview

Hardship distributions allow active plan participants to access their retirement funds if they have an “immediate and heavy financial need”, and under a limited set of circumstances prior to the retirement age of 59½. Unlike a plan loan, a hardship distribution doesn’t need to be repaid, but it is limited to only the amount necessary to cover the specific emergency (plus taxes and expenses incurred from withdrawing the funds).

Before these recent reforms were enacted, hardship withdrawals were treated as an option of last resort, with many plans requiring individuals to exhaust any 401(k) or 403(b) loan options they had before a hardship withdrawal would be made available. Employees were also prohibited from making any further contributions to the retirement account for the six months following the hardship withdrawal. To issue a hardship withdrawal, plan sponsors were required to apply a “facts and circumstances” test to assess whether the participant has an immediate and heavy financial need that cannot be solved by any other source.

The 2019 hardship distribution regulations expand these rules to permit enhanced access to retirement funds under a broader set of circumstances.

Final IRS Regulations

The final regulations enacted in September 2019 make several key changes in the way hardship distributions is administered.

Notable Changes

Elimination of 6-Month Contribution Restriction: For any hardship distributions made on or after January 1, 2020, plan sponsors cannot impose a 6-month suspension period on employee contributions following a distribution. (Not applicable to unfunded nonqualified plans.)

“Facts and Circumstances” Test Eliminated: Beginning January 2020, plan sponsors must eliminate the “facts and circumstances” test used to determine whether a participant has an adequate need for a hardship distribution. Instead of this test, which was often criticized as both overly stringent and invasive, plan sponsors will use a determination that requires participants to affirm, in writing, that:

• The requested hardship distribution does not exceed their actual financial need;
• The participant has already taken all other available distributions, including dividends from an employee stock ownership plan (but not hardship distributions or loans); and
• The participant represents in writing, electronic medium, or other forms approved by the IRS that the individual has insufficient cash or “reasonably available” liquid assets to satisfy their serious financial need.

Removal of Requirement to First Take Plan Loans: Initially a condition, plan sponsors may now choose to retain or eliminate the requirement for participants to exhaust plan loan prior to being eligible for a hardship distribution. While there can be strategic reasons to keep this requirement, participants are required only to exhaust the withdrawals that are already penalty-free (like ESOP dividends).

Allowance for Disaster-Related Distribution: In addition to federally declared disasters, participants are eligible for hardship distributions for FEMA-declared disasters, as long as the disaster occurred in the area of the employee’s primary residence or place of employment. Plan sponsors must add disaster-related distributions to the list of permissible expenses in their plan document by end of plan year in which they permit distributions to be made.

Observations

The final regulations allow plan sponsors to issue hardship distributions from accounts that hold elective deferrals, traditional safe harbor contributions, qualified non-elective employer contributions (QNECs), and qualified matching contributions (QMACs)—essentially all the employer contributions that were previously made unavailable for withdrawal.

However, for 403(b) plan sponsors, except in a few limited circumstances, hardship distributions may not be issued on any earnings that are attributed to elective deferrals, QNECs, and QMACs.

Plan Amendments

All plan sponsors must amend their plan documents to reflect the mandatory changes and any optional changes they want to implement. But while many of these changes become effective in January 2020, non-governmental 401(k) plans have about two years to adopt these changes officially; until then, adopting interim amendments to expand hardship withdrawals is sufficient.

The “due date” for these interim amendments is tied to the tax filing deadline, which can be individual to each plan sponsor. A plan administrator can take the sting out of this process by reviewing the current hardship distribution procedures, determining which must be changed, extending these changes to other plan documents (like safe harbor notices), and then working with the plan sponsor to outline a plan on the optional amendments.

How PlanPILOT Can Help

Plan sponsors are strongly encouraged to review their plan documents and the final hardship distribution regulations so they are prepared to make the necessary changes in a timely manner. If you need assistance in mending your retirement plan documents, look no further than PlanPILOT. We are an independent Registered Investment Advisor, and our experienced consultants provide tailored advisory services for organizations of all sizes and types. Learn how we work with you to help your plan participants achieve positive outcomes.

Related Posts