Washington Insights – Winter 2019

Jan. 16, 2019 | By Jon Vogler

Jon Vogler
Senior Analyst,
Retirement Research,
Invesco Consulting

Proposed hardship regulations

On Nov. 9, 2018, the Treasury and Internal Revenue Service (IRS) released proposed regulations modifying the rules for hardship distributions under 401(k) and 403(b) plans. The proposed regulations would make revisions to reflect a number of statutory changes in the Bipartisan Budget Act of 2018 (BBA) and other laws.

The BBA deleted the six-month suspension of deferrals after a hardship distribution. The proposed regulations would require that a plan eliminate this feature. However, because of the lateness of the proposed regulations, this change would have a delayed effective date; instead of going into effect on Jan. 1, 2019, it would apply only to distributions made on or after Jan. 1, 2020. (For distributions made during the period before Jan. 1, 2020, but within a plan year beginning after Dec. 31, 2018, plans are permitted to continue to apply the six-month suspension. Regarding suspensions that are in effect as of Jan. 1, 2019, the proposal gives plans the option to either terminate the suspension period early [as of Jan. 1, 2019], or to allow it to continue for the remainder of the scheduled six-month period.)

The BBA also provided that a participant would no longer have to take available loans from the plan (and all other plans of the employer) prior to taking a hardship distribution. The proposed regulations clarify that the plan sponsor may keep this loan requirement if it so chooses. The BBA modified Internal Revenue Code (“Code”) Section 401(k) to allow the withdrawal of earnings on elective deferrals, as well as the withdrawal of qualified matching contributions, plus earnings, and qualified nonelective contributions, plus earnings. However, the proposed regulations allow the plan sponsor to continue to restrict the types of contributions available for hardship distributions, and whether earnings on those contributions are included.

In lieu of the prior rules about the six-month suspension of deferrals and the need to take loans prior to hardship withdrawals, the proposed regulation would provide two conditions about satisfying an immediate and heavy financial need for the safe harbor.

First, the employee must obtain all other currently available distributions (but not hardship distributions) under the plan and all other plans of deferred compensation, whether qualified or nonqualified, maintained by the employer. Second, the employee must represent in writing that he or she has insufficient cash or other liquid assets to satisfy the need. The IRS has declared that a plan administrator may rely on such a representation unless the plan administrator has actual knowledge to the contrary.

The regulations include a safe harbor list of six categories of expenses that are deemed to constitute an immediate and heavy financial need. The proposal expands this list in three ways:1

  1. The proposal provides that three of the categories (medical, educational and funeral expenses) now include expenses incurred by a “primary beneficiary” of the participant under the plan.
  2. Regarding the category of expenses for repairing damage to the employee’s residence that would qualify for the casualty deduction under Code Section 165, the proposal clarifies that the new limitations that the Tax Reform Act added to Code Section 165 (i.e., a deduction was available only if the damage to the principal residence occurred because of a federally declared disaster) do not apply for hardship purposes.
  3. The proposal adds a new seventh category to this list: expenses and losses incurred on account of a disaster declared by the Federal Emergency Management Agency (FEMA), if the employee’s principal residence or principal place of employment was located in an area designated by FEMA for individual assistance. Currently, the IRS grants this relief on an ad hoc basis after such disasters. By including this category in the safe harbor, the IRS intends to eliminate the delay and uncertainty that plans often experienced following such disasters.2

Comments about the proposed hardship regulations are due by Jan. 14, 2019.

Multiemployer plans

Over 10 million workers and retirees are covered by 1,400 multiemployer pension plans, which are created under collective bargaining agreements and jointly funded by groups of employers in industries like construction, mining and food retailing. Each employer generally negotiates a contribution rate with the union, and workers accrue retirement benefits based on those negotiated benefits (which may vary based on the specific contract the union has with a given employer, but still allow workers to reliably accrue benefits even while switching employers).3

Plans covering 1.3 million workers and retirees are severely underfunded — the result of stock market crashes in 2001 and 2008 to 2009, and industrial decline that led to consolidation and sliding employment4. While the majority of multiemployer plans have returned to financial health since the financial crisis, a substantial minority (covering about 1 million of the 10 million participants) face serious funding problems and could run out of money within the next 15 to 20 years5. Plans are underfunded by a total of $48.9 billion, according to estimates from Cheiron, an actuarial consulting firm.4

Meanwhile, the Pension Benefit Guaranty Corporation, the federally sponsored insurance backstop for defunct plans, expects its multiemployer insurance program to run out of money within 10 years, absent reforms.

Congress approved an overhaul in 2014, the Multiemployer Pension Reform Act (MPRA), but the legislation has faced strong resistance from retiree organizations, consumer groups and some labor unions.

The MPRA allowed plans facing impending insolvency to cut accrued benefits if approved by the Treasury. The notion was that spreading the pain could produce a more equitable outcome than paying full benefits until the money ran out and then leaving retirees with no benefits at all. A key criterion for approving MPRA cuts, however, is that the plan must be sustainable once the cuts are made.5 Benefit cuts vary widely depending on what a plan proposes and the tenure of the worker, but in some cases, the cuts can be dramatic. 

In 2018, the special congressional committee (the Joint Select Committee on Solvency of Multiemployer Pension Plans) appointed to create a replacement for the MPRA missed an end-of-November deadline to issue its recommendation. But a draft proposal raises the guaranteed minimum benefits paid by the PBGC if a plan fails. It also would inject federal funds into the agency (perhaps $3 billion annually)  to expand its "partition" program, which allows it to take on benefit payments to so-called orphans — people who earned benefits from employers who have dropped out of plans, often because they have gone out of business. [Under “partition,” early financial assistance from PBGC along with required benefit reductions helps the plan to avoid insolvency and pay benefits to participants over the long term.]

The sticking points in the discussion have included the assumptions used to measure plan liabilities, and how much respective stakeholders (including the government) should contribute to maintain a viable multiemployer system, says Karen Friedman, Executive Vice President of the Pension Rights Center, an advocacy group: “We’re hoping they can find a fair, comprehensive solution that can save these plans, the PBGC and protect workers and retirees.”4

On Jan. 9, 2019, Rep. Richard Neal, D-MA, Chairman of the House Ways & Means Committee, introduced a bill in Congress (the Rehabilitation for Multiemployer Pensions Act) which would provide a loan program within the Treasury Department for multiemployer plans that are in critical and declining status.

As always, we’ll keep you posted.

  1. Investment Company Institute (ICI), “IRS issues proposal to modify 401(k) regulations on hardship distributions,” Shannon Salinas, Nov. 16, 2018
  2. PlanSponsor, “IRS proposes amendments to hardship withdrawal regulations,”  Rebecca Moore, Nov. 12, 2018
  3. Forbes, “A tale of two multiemployer plan (systems),” Elizabeth Bauer, Nov. 27, 2018
  4. The New York Times, “For American workers, 4 key retirement issues to watch in 2019,” Mark Miller, Dec. 20, 2018
  5. MarketWatch, “Opinion: multiemployer pension plans can’t cut their way to solvency,” Alicia H. Munnell, Sept. 12, 2018

The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It is not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding tax penalties that may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax advisor for information concerning their individual situation.