The IRS recently released proposed regulations, generally effective January 1, 2019, that provide important clarifications for plan sponsors and offer additional relief regarding hardship circumstances and other requirements. The proposed regulations follow the issuance of The Bipartisan Budget Act of 2018 (the “Act”), signed into law on February 9. Under the Act, all plans must eliminate the six-month suspension for hardship withdrawals made on and after January 1, 2020, and plans can elect to eliminate the six-month suspension for hardships—even on existing hardships—as early as January 1, 2019.
The proposed regulations include the following important clarifications and changes:
- 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 can choose to eliminate the six-month suspension as early as plan years beginning on or after January 1, 2019. In addition, the proposed regulations clarify that plan sponsors may eliminate suspensions that are in place as of December 31, 2018.
- Elimination of Requirement to Take Plan Loans First. The Act provided that participants would no longer be required to take available plan loans before electing a hardship withdrawal. While the proposed regulations eliminate this requirement 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 proposed 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 proposed 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. The normal rules for implementing the amendments will apply and are anticipated to be required in 2019 after the final regulations have been issued. If using a pre-approved plan document, check with your plan provider to see if any amendments are needed.