401(k) plans are often the go-to retirement account structure for businesses looking to add a retirement benefit and individuals looking for tax savings. New regulations from the IRS have been in the works to adopt updates to hardship plan distributions. and the IRS published the final version of the updated hardship distribution regulations on September 23 (the “Final Regulations”). Current regulations state that distributions can be made from the elective contribution portion of the 401(k) only upon certain events: “death, disability, severance from employment, termination of the plan, attainment of age 59 ½, hardship, or, in the case of a qualified reservist distribution, the date a reservist is called to active duty.”
Various sections of the IRS regulations have been updated over the last several years to reflect changes in national policy towards hardship distributions. In particular, Code Section 1.401(k)-1(d)(3) focuses on the employee’s hardship and states that there must be an “immediate and heavy financial need” for the distribution to qualify as a hardship distribution. Further, the distribution cannot be greater than the amount of the need, plus the costs of taxes and penalties associated with withdrawing the funds from the account.
The Bipartisan Budget Act of 2018 (“BBA”) provided for a few key changes to the laws regarding hardship distributions that the Final Regulations address. Specifically, the BBA removed a prohibition on making further contributions to a 401(k) for 6 months after a hardship distribution, meaning individuals can now continue contributing into a 401(k) immediately after taking the distribution. Further, the BBA changed the maximum amount available to an individual to take as a hardship distribution. Finally, the BBA specified that an individual must be allowed to take a hardship distribution even if they choose not to take a loan from the plan first.
“Immediate and Heavy Financial Need”
Similar to the proposed regulations, the final version includes a safe harbor list of situations where distributions are automatically considered to be for “immediate and heavy financial need.” The Final Regulations added disaster-related expenses of an employee living in a disaster area to the list of safe harbors. Further, the rules relating to how the distribution was necessary to satisfy the financial need were modified as discussed above to remove the requirement that employees take out a loan before taking a distribution and refrain from continuing to make contributions. Additionally, pursuant to the Final Regulations, employees are allowed to represent to their company “in writing” their need and this writing can now be in electronic format.
Elective Contributions, QNECs, QMACs
The new regulations allow (but do not require) for an increased list of sources of 401(k) funds an employee can reach into for their hardship distribution. These sources now include elective contributions to the 401(k), Qualified Non-Elective Employer Contributions (QNECs), Qualified Matching Contributions (QMACs), and the earnings on each of these amounts. Plans are allowed to implement other limitations to hardship distributions, such as stating a minimum amount that must be available for a distribution or limiting the types of contributions or earnings available for the distribution.
Section 403(b) Plans
Schools and charities that offer 403(b) plans to their employees are subject to the same Final Regulations regarding hardship distributions as 401(k) plans, except that income attributed to elective deferrals continues to be ineligible for hardship distributions. Further, QNECs and QMACs in 403(b) plans are only eligible for contribution if they are not held in a custodial account.
Because these regulations were issued in response to the BBA, employers have some flexibility to choose when they apply the new rules to plan documents and associated distributions. Adoption of the hardship changes is permissive from While all plans must comply beginning January 1, 2020, plans may choose to modify so that hardship distributions made in the second half of 2018 and onwards comply. Since the Final Regulations are very similar to the proposed versions, 401(k) plan administrators have had an opportunity to see what changes are likely coming from the IRS and make pre-emptive changes to plan documents accordingly.
All 401(k) and 403(b) plans should undergo legal review periodically to ensure they comply with all current and proposed laws and regulations. Further, this review should include a discussion of upcoming regulations and whether pro-active compliance with these regulations is feasible and beneficial.