What you need to know about the final regulations for hardship withdrawals from 401(k) and 403(b) plans
On September 19, 2019, the Internal Revenue Service released final regulations for hardship withdrawals from 401(k) and 403(b) plans, addressing changes made by the Bipartisan Budget Act of 2018 and The Tax Cuts and Jobs Act of 2017. These final regulations are substantially similar to the IRS proposed regulations. The final hardship regulations are effective for hardship distributions made on or after January 1, 2020.
Summary of the Final Hardship Regulations
- Elimination of Six-Month Suspension.
- All 401(k) and 403(b) plans—including safe harbor 401(k) plans—must eliminate the six-month suspension beginning with hardship distributions made during plan years beginning on and after January 1, 2020.
- Plan sponsors may eliminate suspensions that are in place as of December 31, 2018.
- Elimination of Requirement to Take Plan Loans First.
- Plans may choose to continue imposing it.
- For any distribution made on or after January 1, 2020, the participant must provide a written representation that he or she has insufficient cash to satisfy the financial need, and the plan administrator may rely on such representation in the absence of actual knowledge that this is untrue.
- Expansion of Accounts Eligible for Hardship Distributions.
- The Act permits but does not require that a plan sponsor may expand available sources of funds available for hardship distributions.
- Plan sponsors may now allow for: earnings on elective deferrals, Qualified Non-Elective Contributions (QNECs), and Qualified Matching Contributions (QMACs), and safe harbor 401(k) plan contributions (whether matching or nonelective).
- 403(b) Plan Differences: The final regulations do not modify the 403(b) rules to permit withdrawal of earnings on 403(b) elective deferrals or QNECs/QMACs that are in custodial accounts.
- Expansion of Existing Safe Harbor Circumstances.
- The current regulations provide a safe harbor where the following expenses automatically (i.e., are “deemed” to) satisfy the requirement to be on account of an immediate and heavy financial need: (1) unreimbursed medical expenses of the participant or primary beneficiary, (2) purchase of principal residence, (3) post-secondary school tuition, fees, room and board for 12 months for an employee, spouse, child or primary beneficiary, (4) to avoid eviction or foreclosure, (5) to repair damage to a principal residence as a “casualty loss” under Code section 165, or (6) funeral expenses.
As noted above, current regulations permit a hardship withdrawal generally for a “casualty loss” as defined under Code section 165 (without regard to certain limitations). When the Code section 165 casualty loss provision was changed following the Tax Cuts and Jobs Act of 2017 to require that the loss be incurred due to a federally declared disaster, it was unclear how hardship withdrawals may be impacted. The final regulations clarify that the Tax Act change does not apply to hardship distributions (i.e., a hardship distribution regarding damages to the principal residence is not tied to a federally declared disaster).
The IRS also added a new hardship withdrawal circumstance for expenses or losses (including loss of income) incurred on account of a federally declared disaster if the participant’s principal residence or principal place of employment is located in the area designated by the Federal Emergency Medical Agency for individual assistance at the time of the disaster.
Plan sponsors should review the above changes and determine which optional provisions they want to implement in 2019 and discuss with their recordkeeper operational changes available. Plan amendments will be needed to reflect these changes. Revenue Procedure 2020-9 extended the deadline, applicable to pre-approved plans, for adopting an interim amendment relating to the hardship distribution regulations to December 31, 2021.