IRS Issues Final Hardship Distribution Rules
The Internal Revenue Service has recently issued final regulations easing requirements for hardship distributions from 401(k) and 403(b) plans. The final regulations reflect a number of statutory changes, including those made under the Bipartisan Budget Act of 2018, as mentioned in our December 2018 Advisory.
401(k) and 403(b) plans may allow for a distribution of deferred compensation following an employee hardship if (i) the distribution is made on account of an immediate and heavy financial need and (ii) the distribution is necessary to satisfy the financial need. As described below, the final regulations revise the hardship distribution rules to make it easier to meet these requirements, as well as to expand the permissible sources from which hardship distributions can be made. While employers are not required to amend their plan’s hardship provisions by the end of 2019, employers should be prepared to implement certain administrative changes no later than the beginning of 2020 and to update employee communications accordingly.
The following is a brief overview of the new hardship distribution rules.
Reason for Distribution
The final regulations expand the types of immediate and heavy financial needs that will automatically qualify as a hardship by:
- adding a new type of safe harbor for expenses incurred as a result of a FEMA declared disaster;
- expanding the safe harbor for casualty expenses by eliminating the declared disaster requirement; and
- permitting certain safe harbor expenses to be incurred for the participant’s primary beneficiaries under the plan.
Need for Distribution
The final regulations relax the rules for determining whether a distribution is necessary to satisfy an immediate and heavy financial need by:
- eliminating the requirement to take out a plan loan prior to obtaining a hardship distribution;
- prohibiting making hardship distributions conditioned on a suspension of elective deferrals; and
- replacing the facts and circumstances standard for determining necessity with a less subjective, easier to apply standard.
Source of Distribution
Whereas under the prior rules hardship distributions were limited to elective deferrals, the final regulations permit distributions from elective deferrals, QNECs, QMACs, safe harbor contributions and earnings on all these amounts. For 403(b) plans, however, a hardship distribution is not permitted from QNECs and QMACs held in a custodial account or from earnings on elective deferrals.
Employers may allow hardship distributions from these new sources starting January 1, 2019. Employers are not, however, required to allow hardship distributions from all permissible sources.
401(k) and 403(b) plan hardship provisions should be amended as needed to reflect the new regulations by the following dates:
- Individually designed 401(k) plans - the amendment deadline for required and optional changes is December 31, 2021 for calendar year plans, or possibly later depending on further IRS guidance.
- Pre-approved 401(k) plans - the amendment deadline varies depending on several factors, including the type of plan sponsor and the period used for the plan year. We recommend employers contact their prototype sponsors now to address needed amendments prior to an applicable deadline.
- Individually designed and pre-approved 403(b) plans - the amendment deadline is March 31, 2020, but the IRS is considering extending the deadline.