On September 23, 2019, the Department of the Treasury and the Internal Revenue Service released final regulations amending the rules applicable to hardship distributions from 401(k) plans. The final regulations are substantially similar to the proposed regulations issued on November 14, 2018 (described in this previous blog post), such that plans that have been amended to comply with the proposed regulations will also satisfy the final regulations.
New Rules For Determining “Immediate and Heavy Financial Need”
The final regulations amend the list of safe harbor expenses that are deemed to be made on account of an immediate and heavy financial need as follows:
- Qualifying medical, educational and funeral expenses for an employee’s “primary beneficiary” will now be deemed to be made on account of an immediate and heavy financial need. A “primary beneficiary” refers to an individual who is named as a beneficiary under the plan and has an unconditional right to all or a portion of the employee’s plan account after the employee’s death. This is intended to reflect Section 826 of the Pension Protection Act, which requires that an employee’s beneficiary be treated on the same footing as the employee’s spouse or dependent in determining whether the employee has incurred a hardship.
- Expenses and losses (including loss of income) incurred by the employee on account of a FEMA-declared disaster will now be deemed to be made on account of an immediate and heavy financial need if, at the time of the disaster, the employee’s principal residence or principal place of employment was located in an area designated by FEMA for individual assistance with respect to the disaster. The final regulations clarify that this does not cover expenses and losses of the employee’s relatives or dependents.
- The determination as to whether expenses for the repair of an employee’s principal residence qualify for a casualty deduction under Section 165 of the Internal Revenue Code can be made without regard to whether the loss is attributable to a federally declared disaster. This is intended to exclude the application of Section 165(h)(5) of the Internal Revenue Code, which was added by Section 11044 of the Tax Cuts and Jobs Act.
New Rules For Determining “Necessity”
The final regulations replace the previous “facts and circumstances” test for determining necessity with a new general standard. A distribution will now be treated as necessary to satisfy an immediate and heavy financial need only if all of the following conditions are satisfied:
- The amount of the distribution does not exceed the amount required to satisfy the need (including any amounts necessary to pay federal, state or local income taxes or penalties reasonably anticipated to result from the distribution).
- The employee has obtained all other currently available, non-hardship distributions under the employer’s plans (including non-qualified plans).
- The employee represents to the employer (whether in writing, verbally by telephone, or other permissible electronic medium) that he or she has insufficient cash or other liquid assets reasonably available to satisfy the need. The final regulations clarify that an employee may make this representation even if he or she has cash or other liquid assets on hand, provided that those assets are earmarked for payment of an obligation in the near future (such as rent).
- The plan administrator must not have actual knowledge that is contrary to the employee’s representation. The final regulations clarify that this is limited to any information already possessed by the administrator; the plan administrator need not investigate an employee’s financial condition in order to determine the veracity of the employee’s representation.
A plan can impose certain additional conditions to demonstrate the necessity of a hardship distribution, such as a requirement to complete a plan’s application process and to provide relevant documentation, or the establishment of a nondiscriminatory, minimum dollar amount for hardship distributions.
However, a plan can no longer impose a suspension of elective contributions and employee contributions as a condition to obtaining a hardship distribution. In particular, the final regulations eliminate the six-month suspension on elective contributions and employee contributions following a hardship distribution previously required under the applicable Treasury regulations. This change is intended to remove any impediment on the ability of employees to replace distributed funds.
In addition, under the final regulations, an employee is no longer required to take all non-taxable plan loans before a hardship distribution may be made. However, a plan is permitted to retain this requirement as a condition to demonstrating necessity.
New Sources For Hardship Distributions
The final regulations provide that a plan may, but need not, permit hardship distributions to be made from qualified non-elective contributions (QNECs), qualified matching contributions (QMACs), safe harbor contributions and earnings on elective contributions, QNECs, QMACs and safe harbor contributions, regardless of when contributed or earned.
The final regulations apply to hardship distributions made on or after January 1, 2020. Earlier application of these rules is also permitted as follows:
- The final regulations may be applied to hardship distributions made in plan years beginning after December 31, 2018 (disregarding, with respect to such distributions, the requirement to obtain an employee representation or the prohibition on the suspension of contributions).
- The prohibition on the suspension of elective contributions and employee contributions may be applied as of the first day of the first plan year beginning after December 31, 2018 (including for hardship distributions made in a previous plan year).
- The new list of safe harbor expenses deemed to be an immediate and heavy financial need may be applied to hardship distributions made on or after January 1, 2018.
Next Steps for Plan Sponsors
- Plan sponsors should amend their 401(k) plan to address the mandatory changes set forth in the final regulations (such as the elimination of any suspension on elective contributions and employee contributions following a hardship distribution). Any such amendment must be effective for hardship distributions beginning no later than January 1, 2020, and must be adopted by the deadline set forth in Revenue Procedure 2016-37, 2016-29 I.R.B. 136. Generally, for individual plans (excluding governmental plans), the deadline will be the end of the second calendar year following the year in which the Required Amendments List containing such changes is issued. For example, if the changes are included in the Required Amendments List for 2019, the deadline will be December 31, 2021.
- Plan sponsors should consider whether their 401(k) plan should adopt any of the permissive changes set forth in the final regulations (such as allowing plan participants to take a hardship distribution without first exhausting non-taxable plan loans, or expanding the types of contributions from which hardship distributions may be made).
- Plan sponsors are encouraged to consult with legal counsel about amending their 401(k) plans to reflect any mandatory or permissive changes described in the final regulations.
- Plan sponsors of 403(b) plans should consult with legal counsel to determine how the final regulations affect hardship distributions under 403(b) plans.