Proposals would modify hardship distribution rules for qualified retirement plans

Tax Hot Topics newsletterThe IRS recently issued proposed regulations (REG-107813-18) under Sections 401(k) and (m) to reflect the application of the hardship distribution rules in light of changes to the casualty loss deduction rules made by the Tax Cuts and Jobs Act (TCJA) and to address other statutory changes affecting Section 401(k) plans.

The proposed regulations modify the current safe harbor list of expenses for which distributions are deemed to be made on account of an immediate and heavy financial need of a plan participant. They specify that the new casualty loss deduction limitations under the TCJA do not apply for applicable expenses. In addition, the list includes a new type of expense incurred as a result of certain disasters, similar to relief given by the IRS after major federally declared disasters.

The proposed regulations also modify the rules for determining whether a distribution is necessary to satisfy an immediate and heavy financial need by eliminating the following provisions:

  • Any requirement that an employee be prohibited from making elective contributions and employee contributions after receipt of a hardship distribution
  • Any requirement to take plan loans before obtaining a hardship distribution
  • The safe harbor under which a distribution is deemed necessary to satisfy a financial need only if elective contributions and employee contributions are suspended for at least six months after a hardship distribution is made and nontaxable plan loans, if available, are taken

In addition, the proposed regulations eliminate the current rules under which the determination of whether a distribution is necessary to satisfy a financial need is based on all relevant facts and circumstances and provide one general standard with the following three requirements:

  • The hardship distribution may not exceed the amount of an employee’s need (including amounts necessary to pay income taxes and penalties reasonably anticipated to result from the distribution)
  • The employee must have obtained other available distributions under the employer’s plan
  • The employee must represent that he or she has insufficient cash or other liquid assets to satisfy the financial need

Further, the proposed regulations clarify that a plan generally may provide for additional conditions to demonstrate that a distribution is necessary to satisfy an immediate and heavy financial need of an employee. However, a plan may not provide for a suspension of elective contributions or employee contributions as a condition of obtaining a hardship distribution. This prohibition would only apply for a distribution made after Dec. 31, 2019.

The proposed regulations permit hardship distributions from Section 401(k) plans of elective contributions, qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and earnings on those amounts, regardless of when contributed or earned. However, plans may limit the type of contributions available for hardship distributions and whether earnings on those contributions may be included. Safe harbor contributions made to a plan described in Section 401(k)(13) may also be distributed on account of an employee’s hardship.

Under the proposed regulations, a hardship distribution of elective contributions from a Section 401(k) plan would generally apply to Section 403(b) plans, but income attributable to Section 403(b) elective deferrals would remain ineligible for distribution due to hardship. Similar treatment would apply to amounts attributable to QNECs and QMACs in a Section 403(b) plan that are not in a custodial account, but QNECs and QMACs in a Section 403(b) plan that are in a custodial account continue to be ineligible for distribution on account of hardship.

The proposed regulations generally apply to distributions made in plan years beginning after Dec. 31, 2018, but there are a number of special applicability dates provided that would allow certain provisions to be applied earlier or later. In addition, although not completely clear, it appears plan sponsors can rely on the proposed regulations as of the respective proposed applicability dates.

Comments and public hearing requests regarding the proposed regulations are due by Jan. 14, 2019.

Jeff Martin
Partner, Washington National Tax Office
T +1 202 521 1526

Keith Mong
Managing Director, Washington National Tax Office
T +1 202 521 1554

James Sanchez

Senior Associate, Washington National Tax Office
T +1 202 861 4107

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