401(k) plan hardship distribution rules clarified

Tax Hot Topics newsletterThe IRS recently issued final regulations under Sections 401(k) and (m) to offer guidance on 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 reflect other statutory changes affecting Section 401(k) plans. The final regulations are substantially similar to the proposed regulations issued in November 2018, and the IRS indicated that plans that complied with the proposed regulations would also satisfy the final regulations.

The final 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. The changes 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. In fact, the IRS indicated that no more disaster-specific relief announcements will be needed in the future.

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

  • 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 final 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 provides 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 final 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.

The final regulations permit hardship distributions from Section 401(k) plans of elective contributions, qualified non-elective 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 may specify whether earnings on those contributions can be distributed. Safe harbor contributions made to plans described in Sections 401(k)(12) and (13) may also be distributed on account of an employee’s hardship.

Under the final regulations, the new hardship distribution rules generally apply in the same manner to Section 403(b) plans, but income attributable to Section 403(b) elective deferrals remains ineligible for distribution due to hardship. Similar treatment applies 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 final regulations generally apply to distributions made on or after Jan. 1, 2020, but there are a number of special applicability dates provided that allow certain provisions to be applied earlier. For example, the new rules may be applied to distributions made in plan years beginning after Dec. 31, 2018, and the prohibition on suspending an employee’s elective contributions and employee contributions as a condition of obtaining a hardship distribution may be applied as of the first day of the first plan year beginning after Dec. 31, 2018, even if the distribution was made in the prior plan year. In addition, the revised list of safe harbor expenses may be applied to distributions made on or after a date that is as early as Jan. 1, 2018.

The IRS also explained in the preamble that plan sponsors generally will need to amend their plan’s hardship distribution provisions to reflect the final regulations. The amendment deadline for individually designed plans that are not governmental plans will depend on when the changes required by the final regulations appear on the Required Amendments List (RAL) described in Rev. Proc. 2016-37, which generally is the end of the second calendar year that begins after the issuance of the RAL that includes the changes (for example, the deadline would be Dec. 31, 2021, if the final regulations are included on the 2019 RAL that should be released later this year).

The IRS also addressed the amendment deadline for pre-approved plans (and extended it in certain cases), and mentioned that it is considering separate guidance that may provide for an amendment deadline for certain 403(b) plans that is later than the current remedial amendment deadline of March 31, 2020, for such plans.

Jeff Martin
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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