Washington Insights – Winter 2019
Jan. 16, 2019 | By Jon Vogler
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
- 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.
- 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.
- 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.