Recently issued IRS final regulations updating the hardship distribution rules for 401(k) and 403(b) defined contribution (DC) plans are “substantially similar” to the 2018 proposal, with only a few minor clarifying changes. However, the preamble gives some helpful answers to questions IRS received in comments on the proposed rules. The final rules generally are effective for distributions on or after Jan. 1, 2020, but sponsors have options for applying the rules sooner.
Under existing regulations for Internal Revenue Code Section 401(k), plans can make hardship distributions if two conditions are met:
A distribution is not considered necessary to satisfy an immediate and heavy financial need to the extent the employee has other resources (including assets of the employee’s spouse and minor children) reasonably available to relieve that need. Unless the employer has actual knowledge to the contrary, it may rely on the employee’s representations that no other resources are available to meet the need.
Employers must make hardship determinations by reviewing all relevant facts and circumstances and applying nondiscriminatory and objective standards set forth in the plan. However, to simplify administration, the regulations include certain safe harbors that employers may use to decide whether a distribution satisfies these requirements.
Expense safe harbors. The regulations deem distributions for certain types of safe harbor expenses (the "expense safe harbors") to be on account of an immediate and heavy financial need. Plans can use the facts-and-circumstances test, the expense safe harbors, or both for handling hardship distribution requests.
Necessity safe harbor. Another safe harbor deems a distribution necessary to satisfy the financial need if the employee both:
The final rules are almost identical to the proposal, with just a few changes as noted below. (For a detailed explanation of the proposed rules, see IRS Proposes Updates to Hardship Withdrawal Rules, Nov. 27, 2018.)
Changes to Expense Safe Harbors
The new rules make the following changes to the expense safe harbors:
The final rules adopt these changes without modifying the proposal.
More information on new expense safe harbor. In the preamble to the final rules, IRS says the new safe harbor should eliminate the need to issue ad hoc relief for specific disasters. Past grants of disaster relief typically relaxed the procedural requirements for hardship distributions and loans and allowed plans that didn’t already provide for those distributions to make them to affected employees, as long as the plans were later amended by a deadline set in the announcement.
IRS also points out three key differences between the new expense safe harbor and prior disaster relief:
Distribution Necessary To Satisfy Financial Need
The new rules replace both the facts-and-circumstances test and the necessity safe harbor with one general standard for determining whether a distribution is necessary. The new standard incorporates aspects of both the old facts-and-circumstances test and the necessity safe harbor:
Suspensions no longer allowed. The Bipartisan Budget Act of 2018 (BBA) (PL 115-123) directed Treasury to amend the 401(k) regulations for plan years starting after Dec. 31, 2018, to eliminate the necessity safe harbor’s requirement to suspend an employee’s elective deferrals and other employee contributions for six months after a hardship distribution. The new rules make this change, but (like the proposed rules) go even further by prohibiting suspensions effective for all hardship distributions made on or after Jan. 1, 2020.
The proposed rule didn’t specify whether the prohibition on suspensions applies to all of the employer’s plans. However, the final rule makes clear that the prohibition applies to qualified plans, 403(a) and 403(b) plans, and 457(b) plans maintained by governmental employers, but not nonqualified plans. Employers can keep suspension provisions in a nonqualified plan (or eliminate them to the extent consistent with Section 409A).
The preamble also confirms that the prohibition on suspensions applies to matched employee contributions. (Some earlier IRS revenue rulings said plans must place a substantial limitation, such as a suspension of contributions, on an employee’s right to withdraw matched employee contributions.)
Plan loans. Unlike the old necessity safe harbor, the new general standard does not require participants to take out all nontaxable plan loans under all of the employer’s plans. However, plans may require employees to exhaust plan loans before taking a hardship distribution.
Other conditions on hardship distributions. The preamble confirms that plans may place other conditions on hardship distributions, for example:
Availability of cash and liquid assets. One revision to the final rules makes clear the representation that an employee has insufficient assets to meet the financial need reflects only cash or other liquid assets “reasonably available” to the employee. For instance, an employee with cash or other liquid assets on hand can still satisfy this requirement if those assets are earmarked for other obligations (such as rent).
Representations via electronic medium. IRS tweaked the final rule to clarify that an employee can make the required representation via any electronic medium that’s permissible for participant notices and elections (such as telephone, email or websites).
No requirement to inquire about employees’ finances. Plan administrators don’t have to inquire into the financial condition of employees who ask for hardship distributions. The “actual knowledge” condition is limited to situations when the administrator already has sufficiently accurate information about the employee to determine whether the representation is true.
Expanded Sources of Hardship Distributions (QNECs and QMACs)
Hardship distributions can now be made from elective contributions, qualified nonelective contributions (QNECs), qualified matching contributions (QMACs) and earnings on these amounts. The preamble confirms that this includes QNECs and QMACs in safe harbor plans — both traditional safe harbor plans and qualified automatic contribution arrangements (QACAs). A plan may limit the types of contributions available for hardship distributions — plans that don’t already offer distributions from all these sources needn’t be amended to do so.
The preamble also clarifies the following:
Section 403(b) Plans
Although the final rules generally apply to hardship distributions from 403(b) plans, the preamble clarifies and confirms several issues for those plans:
The final rules are effective for hardship distributions made on or after Jan. 1, 2020 — rather than plan years beginning after Dec. 31, 2018, as stated in the proposed rules. However, employers can choose to apply the final rules for distributions made in 2019. Employers that decide not to apply the new rules this year must follow the existing regulations on hardship distributions until 2020, but can implement any statutory changes already in effect (such as elimination of the necessity safe harbor’s suspension requirement).
Employers that apply the new rules before 2020 should note the following:
IRS expects that sponsors will need to amend their plans to reflect the final regulations. The amendments must be effective for distributions beginning no later than Jan. 1, 2020, and adopted by the deadline for amending disqualifying provisions under Rev. Proc. 2016-37. For purposes of the hardship rules, this deadline applies to both required amendments to correct disqualifying provisions (e.g., amendments eliminating suspension provisions) and amendments that aren’t required but are integrally related to changes in the qualification requirements (e.g., amendments reflecting the change to the expense safe harbor for deductible casualty losses and the new expense safe harbor for federally declared disasters).
Individually designed plans. For an individually designed plan that is not a governmental plan, the amendment deadline is the end of the second calendar year that begins after IRS issues the Required Amendments (RA) List that includes the change. If the final regulations are included in the 2019 RA List, the deadline will be Dec. 31, 2021 (regardless of the plan year).
Preapproved plans. For preapproved plans, the amendment timing under Rev. Proc. 2016-37 varies depending on several factors, including the type of entity sponsoring the plan and the plan year. For example, if an employer with a calendar-year tax year maintains a calendar-year preapproved plan, the amendment deadline is the tax-filing deadline (plus extensions) for the year in which the plan change takes effect. So, for this employer, the interim amendment deadline for all changes related to the final hardship rules is the employer’s tax-filing deadline (plus extensions) for 2020.
403(b) plans. Several commenters asked for guidance on the amendment deadlines for 403(b) plans (both preapproved and individually designed). Under Rev. Proc. 2017-18, the remedial amendment deadline for 403(b) plan sponsors to adopt plan documents is March 31, 2020. Treasury and IRS may provide a later amendment deadline for amendments relating to the final hardship rules in separate guidance.