On September 23, 2019 the Internal Revenue Service (“IRS”) issued final regulations amending the rules for hardship distributions from 401(k) and 403(b) plans (the “Final Regulations”). The Final Regulations modify the hardship requirements to reflect statutory changes and directives introduced by the Bipartisan Budget Act of 2018, the Tax Cuts and Jobs Act of 2017 and the Pension Protection Act of 2006. The Final Regulations are substantially similar to the proposed hardship regulations issued by the IRS on November 14, 2018.
The Final Regulations, which generally make it easier for plan participants to obtain hardship distributions, include the following changes:
Distributions “Necessary” to Satisfy Financial Need:
The Final Regulations make substantial changes to the analysis applied in determining whether a requested hardship distribution is “necessary” to satisfy an immediate and heavy financial need of an employee. Specifically, the Final Regulations: (1) eliminate the safe harbor that required suspension of employee contributions and exhausting available plan loans; and (2) eliminate the facts and circumstances standard. The Final Regulations replace these two standards with one “general standard” for determining whether a distribution is necessary, which retains parts of the prior standards.
Elimination of Six-Month Suspension/Plan Loan Safe Harbor
The prior hardship regulations provided a safe harbor whereby a distribution would be deemed “necessary” to satisfy an immediate and heavy financial need of an employee if: (1) elective contributions to the 401(k) plan and any other employer plan were suspended for at least six months after a hardship distribution; and (2) currently available, non-hardship distributions (including dividends from an ESOP) and non-taxable loans from the plan or any other plan maintained by the employer were taken before a hardship distribution.
Under the Final Regulations, for hardship distributions on or after January 1, 2020, plan sponsors are prohibited from suspending employee contributions to a 401(k) plan as a condition for obtaining a hardship distribution. Beginning in plan years beginning on or after January 1, 2019, requiring a loan prior to a hardship distribution and suspending employee contributions under nonqualified plans is still permitted, but not required.
New “General Standard” for Determining Whether Hardship Distribution is Necessary
The Final Regulations adopt a new single standard for determining whether a distribution satisfies an immediate and heavy financial need of the employee. Under the new standard, a hardship distribution must meet the following requirements:
- The distribution may not exceed the amount of the employee’s need (including any taxes and penalties reasonably anticipated as a result of the distribution);
- The employee must obtain non-hardship distributions available under the employer’s plans (this includes ESOP dividends); and
- The employee must provide a representation that they have insufficient cash or other liquid assets available to satisfy the financial need. This representation may be made in writing, by an electronic medium (including website, e-mail and, as the Final Regulations clarify, a recorded telephone conversation) and other forms prescribed by the IRS commissioner. The plan administrator may rely on this representation unless it has actual knowledge that is contrary to the employee’s representation.
Additional Sources for Hardship Distributions:
The Final Regulations expand available sources for hardship distributions to include Qualified Non-Elective Contributions (QNECs) and related earnings, Qualified Matching Contributions (QMACs) and related earnings, and earnings on elective contributions, regardless of when these amounts were contributed or earned. Note that the rules for 403(b) plans are different, because the legislation left in place some existing rules for these plans: QNECs and QMACs in a custodial account, and earnings on elective deferrals to a 403(b) plan are not eligible for hardship distribution.
Modifications to Safe Harbor List of Expenses Deemed to Satisfy Financial Need
The Final Regulations modify the existing list of safe harbor expenses for which distributions are deemed to be made on account of an immediate and heavy financial need to:
- Include losses incurred by an employee on account of a disaster declared by the Federal Emergency Management Agency;
- Clarify that expenses for damage to a participant’s principal residence can satisfy the safe harbor requirements even if the residence is not located in a federally-declared disaster area; and
- Add the participant’s primary plan beneficiary to the list of individuals for whom medical, educational, and funeral expenses may qualify under the safe harbor.
Plan Amendment Deadlines
While the Final Regulations generally apply to hardship distributions made on or after January 1, 2020, the deadline for amending a plan’s hardship distribution provisions will vary depending on whether the plan is an individually designed plan, a pre-approved plan, or a 403(b) plan.
Employers with questions about the new hardship distribution rules or who need assistance in amending their plans’ hardship distribution provisions can contact the author or any member of the Stinson LLP Employee Benefits Group.