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IRS Proposes Amendments to Hardship Distribution Rules

Hardship Distributions of Elective Contributions, Qualified Matching Contributions, Qualified Nonelective Contributions, and Earnings, 83 Fed. Reg. 56763 (Nov. 14, 2018)

Available at https://www.govinfo.gov/content/pkg/FR-2018-11-14/pdf/2018-24812.pdf

The IRS has proposed amendments to the 401(k) plan regulations that would affect the funds available for hardship distributions, the events that constitute qualifying hardships, and the standards used to determine whether a participant’s need could be relieved using other reasonably available resources. The amendments incorporate changes made by the Bipartisan Budget Act of 2018 (BBA) (see our Checkpoint article) and several earlier laws, including the Tax Cuts and Jobs Act (TCJA) (see our Checkpoint article) and the HEART Act (see our Checkpoint article). Here are highlights:

  • Funds Available for Hardship Distributions. Consistent with the BBA, the amendments would expand the funds available for hardship distributions to include qualified nonelective contributions (QNECs), qualified matching contributions (QMACS), and earnings (regardless of when they were earned). The amendments would also clarify that safe harbor contributions under a plan using a Code § 401(k)(13) safe harbor design could be distributed. However, plans would retain the ability to limit the types of contributions available for distribution and to choose whether earnings would be distributable.
  • Hardship Events. The amendments make three significant changes to the list of safe harbor events that qualify for hardship distributions. First, the amendments conform the regulations to previous IRS guidance (see our Checkpoint article) allowing distributions for medical expenses, post-secondary education expenses, and burial or funeral expenses, of a “primary beneficiary,” defined as an individual who is named as a beneficiary under the plan and has an unconditional right, upon the death of the employee, to all or a portion of the employee’s account balance. Second, the amendments clarify that the hardship safe harbor for damage to a participant’s principal residence is applied without regard to the TCJA provision that suspended casualty deductions for years prior to 2026 for losses not due to a federally declared disaster. Third, the amendments add a new hardship safe harbor for disaster-related expenses and losses (including loss of income) incurred by an employee , provided that the employee’s principal residence or principal place of employment at the time of the disaster was located in an area designated by the Federal Emergency Management Agency (FEMA) for individual assistance with respect to the disaster. In addition, the proposed amendments would conform the regulations to the HEART Act provisions authorizing “qualified reservist distributions.”
  • Financial Necessity. The BBA amended the Code to provide that a distribution could not be treated as failing to be made due to hardship solely because the participant did not take any available loan. It also directed the IRS to remove the six-month prohibition on new contributions after a hardship distribution. The proposed regulations respond to these statutory changes by eliminating the safe harbor method for showing that a distribution is necessary to satisfy a participant’s need, and establishing one general standard for determining financial necessity. Among other things, that standard would require the participant to represent—in writing, electronically, or by another IRS-approved method—that the participant has insufficient cash or other liquid assets to satisfy the need. Plans could still opt to require participants to take all available nontaxable plan loans, or to impose other conditions, but they could not require suspension of elective and employee contributions as a condition for taking hardship distributions beginning in 2020. Contribution suspensions put into effect earlier could be lifted as early as the start of the first plan year beginning after 2018.
  • Disaster-Relief Guidance. In the preamble to the proposed regulations, the IRS has included a grant of disaster relief for victims of Hurricanes Florence and Michael. That guidance (which is not conditioned upon the issuance of the final hardship regulations) extends the loan and hardship relief provided under Ann. 2017-15 (for victims of Hurricane Maria and the 2017 California wildfires, see our Checkpoint article) to the victims of Hurricanes Florence and Michael. The relief is to be applied using the incident dates specified by FEMA for these 2018 events; it extends through March 15, 2019; and any amendments necessary to reflect the relief will have to be made no later than the deadline for the plan amendments required by the proposed regulations.
  • Plan Amendments. The proposed amendments to the hardship event and financial necessity regulations would apply to distributions made in plan years beginning after 2018. All amendments relating to the final regulations (and to the relief for victims of Hurricanes Florence and Michael) will have same amendment deadline, determined by Rev. Proc. 2016-37 (see our Checkpoint article). For example, for individually designed, nongovernmental plans, the deadline would be the end of the second calendar year beginning after issuance of the required amendments list that includes the change.

EBIA Comment: Some plan sponsors may have hoped they would be allowed to continue applying their current hardship distribution standards without change, leaving in place more stringent conditions than are legally required after the BBA. The proposed regulations, however, make clear that the IRS believes contribution suspension provisions, at least, must be eliminated by 2020. As a result, it appears that even plan sponsors that were willing to leave their old rules in place will have to reconsider their hardship standards, make plan amendments, revise participant communications, and implement new procedures. For more information, see EBIA’s 401(k) Plans manual at Sections XV.B (“Safe Harbor Events Deemed to Be Financial Hardships”), XV.D (“Safe Harbor Standards Deeming Lack of Other Resources”), XV.H (“Distributions: Hardship: Special Rules for Disaster Relief”), XVI.N (“Distributions: Participant Loans: Special Rules for Disaster Relief”), XXVII.E (“Amendment Timing”), and XXVII.G (“Extended Remedial Amendment Periods”).

Contributing Editors: EBIA Staff.

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