QUESTION: I understand that obtaining a hardship distribution from a 401(k) plan requires a certain type of hardship and proof that a 401k plan distribution is necessary to alleviate the hardship. What is the current standard for proving necessity?
ANSWER: In the past (generally, distributions prior to 2020), plans could use either of two standards for determining whether a hardship distribution was necessary: a safe harbor standard or a “non-safe harbor” standard. The safe harbor (1) required a participant to first obtain all currently available distributions and plan loans, and (2) prohibited elective deferrals and after-tax contribution to plans maintained by the plan sponsor for at least six months after the hardship distribution. The non-safe harbor was nominally a determination based on all relevant facts and circumstances, but IRS regulations allowed an employer to rely on a participant’s representation that the need could not reasonably be met by certain specified means (e.g., liquidation of assets, loans, other plan distributions), provided it had no contrary knowledge regarding the participant’s ability to pay.
For distributions made on or after January 1, 2020, there is only one—relatively simple—standard. The new standard imposes only two requirements to establish that a distribution is necessary:
Employees must obtain any other currently available distributions under the plan and any other plan of deferred compensation, whether qualified or nonqualified, maintained by the employer (including distributions of ESOP dividends under Code § 404(k)); and
Employees must represent in writing (including via an electronic medium or in such other form as the IRS prescribes) that they have insufficient cash or other liquid assets reasonably available to satisfy the financial need.
Cash and other liquid assets are not “reasonably available” if they are earmarked for payment of another obligation in the near future, such as rent. A plan administrator cannot accept an employee’s representation if it has actual knowledge contrary to the representation.
Plans can choose to impose only the minimum conditions described above, or they can impose additional conditions if, for example, a plan sponsor is concerned that plan accounts be preserved for retirement. Additional conditions could include requiring that employees first take all nontaxable loans available under all plans maintained by the employer. For distributions made on or after January 1, 2020, however, additional conditions cannot include a required suspension of elective contributions or employee (after-tax) contributions under tax-qualified plans (including 401(k) plans) and certain other retirement plans.
For more information, see EBIA’s 401(k) Plans manual at Sections XV.D (“Establishing a Lack of Other Resources: Distributions Prior to 2020”), XV.E (“General Standard for Determining Lack of Other Resources”), and XV.G (“What Documentation Should Be Required for Hardship Distributions?”).
Contributing Editors: EBIA Staff.