- The Tax Cuts and Jobs Act extends the period a participant may make a tax-free loan rollover to an IRA or other retirement plan from a 401(k) account.
- The Bipartisan Budget Act of 2018 provides administrative ease and flexibility by eliminating the six-month contribution suspension period after a 401(k) plan hardship withdrawal and by broadening permissible contribution sources available for hardship withdrawals.
- The Bipartisan Budget Act of 2018 permits plan sponsors to extend California wildfire disaster-related relief to participants through a plan amendment.
The rules governing 401(k) plans are steadily evolving. Both the Tax Cuts and Jobs Act (the Act) and the Bipartisan Budget Act of 2018 (the Budget) contain a number of changes to the 401(k) plan rules. Changes made by the Act are already in effect, and those made by the Budget will become effective beginning in 2019. These modifications, discussed below, make the administration of 401(k) plans simpler by removing operational burdens, while also giving plan sponsors the ability to offer more options to employees.
401(k) Plan Loans
The Tax Cuts and Jobs Act, signed into law on December 22, 2017, extends the rollover period during which a 401(k) plan participant may pay the amount of an offset of a 401(k) plan loan to an individual retirement account (IRA) or other tax-qualified retirement plan.
Certain employer-sponsored retirement plans, including 401(k) plans, may provide loans to participants if certain regulatory requirements are satisfied. If a participant fails to make timely loan payments, the outstanding loan balance is treated as a taxable “deemed distribution” to that participant. A 401(k) plan may provide, and many do provide, that if a participant terminates employment and has a plan loan outstanding, the participant’s obligation to repay a loan is accelerated.
If the loan is not timely repaid upon acceleration, the participant’s account balance is reduced by the unpaid loan balance, referred to as a “loan offset.” Prior to January 1, 2018, the loan offset amount was eligible for tax-free rollover to another eligible retirement plan, including an IRA, within 60 days of a participant’s termination from employment. If a participant did not roll over the loan offset amount within 60 days, that loan offset became a taxable deemed distribution.
Effective as of January 1, 2018, the period to make a tax-free rollover into another eligible retirement plan, including an IRA, is extended to the participant’s due date for filing his federal tax return. If a participant does not roll over the loan offset amount by the filing due date, that loan offset is a taxable deemed distribution. Under the Act, a participant’s loan can be rolled tax-deferred into an IRA, even if defaulted by the plan before this extended time period.
Plan Sponsor Impact and ActionPlan participants may take advantage of the extended rollover period independently—plan sponsors do not need to amend their plans to extend this time period to participants. Plan sponsors and plan fiduciaries may wish to inform participants of the new opportunity to roll over funds tax-deferred into another eligible retirement plan or IRA through a summary plan description, loan policy or exit package.
Hardship Withdrawals from 401(k) Plans
The Bipartisan Budget Act of 2018, passed in early February, 2018, reduces complex operational burdens previously imposed on employers and plan sponsors. The changes implemented by the Budget apply to plan years beginning after December 31, 2018.
Currently, a participant who receives a hardship withdrawal is prohibited under the safe harbor provisions of the Internal Revenue Code (the Code) from making elective deferral contributions to her 401(k) plan account and exercising stock options during the six-month period following a hardship withdrawal. Under the Budget, and applying to plan years beginning after December 31, 2018, a participant who takes a hardship withdrawal may continue to make, or begin making, elective deferral contributions to her 401(k) account and may exercise stock options following receipt of the hardship withdrawal, should her plan permit this change.
The Budget permits plan sponsors to expand the scope of contribution sources a participant may take a hardship distribution from under a 401(k) plan. Under current law, 401(k) plans may allow participants to take hardship distributions from their elective deferral contributions, discretionary employer profit-sharing contributions, regular matching contributions and earnings on contributions made before December 31, 1988. Beginning after December 31, 2018, 401(k) plans may again permit participants to take hardship distributions from all of the contribution sources listed above as well as qualified non-elective employer contributions (QNECs) and qualified matching contributions (QMACs), and all earnings.
The Budget also allows plan sponsors to remove the requirement that a participant take an available loan from her 401(k) account before taking a hardship withdrawal.
Plan Sponsor Impact and ActionThe Budget allows plan sponsors to make certain changes to their 401(k) plans that alleviate administrative and operational burdens. Previously, a plan administrator was required to track the six-month period after a participant took a hardship withdrawal and restart employee deferrals upon its conclusion. Under the Budget, effective for plan years beginning after December 31, 2018, plan sponsors may remove this inflexible six-month contribution suspension period and can focus attention on other details.
The extension of sources from which an employee may take a hardship distribution will prove beneficial to participants. A participant who suddenly faces a financial challenge will be able to withdraw from a larger pool of funds. Plan sponsors who choose to allow hardship withdrawals from these sources may encourage greater plan participation by non-highly paid employees, making discrimination testing easier. However, plan sponsors may elect not to do so in an effort to be paternalistic in preserving retirement benefits.
To take advantage of both of the Budget’s changes to the 401(k) plan rules, plan sponsors and plan fiduciaries should review their plan documents and hardship withdrawal policies to make changes before 2019 to implement whichever of these provisions they wish to adopt.
Tax Cuts and Jobs Act—Changes to Hardship WithdrawalsThe safe harbor regulations that specify that circumstances under which hardship distributions are available include, among other things, the ability to take a distribution for “the expenses for the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under Section 165 [of the Internal Revenue Code].”
Before the Act, a taxpayer could claim a deduction for certain casualty losses that exceeded $100 and were deductible to the extent they exceeded 10 percent of adjusted gross income. Now, under the Act, casualty losses are only deducible if the damage is attributable to a federally declared disaster. Thus, hardship distributions for personal casualty losses associated with a participant’s residence will only be available if the loss occurs because of a federally declared disaster.
Plan Sponsor Impact and ActionGiven that the above change and its consequences to 401(k) plan hardship withdrawals appears inadvertent, subsequent guidance by the IRS may be issued. In the meantime, plan sponsors should take note to ensure that hardship withdrawals granted for casualty losses meet the criteria for a federally declared disaster.
California Wildfire Relief
Similar to what was enacted in 2017 for victims of Hurricanes Harvey, Irma, and Maria, the Budget includes disaster-related provisions that govern the use of retirement funds as aid. For a detailed summary of disaster-related rules as they apply to taxpayers who suffered hurricane damage, see our alert entitled “Internal Revenue Service Provides Helpful Relief to Hurricane Victims.”
The Budget permits qualified wildfire distributions to be made from October 8, 2017 through December 31, 2018 to an individual who sustained an economic loss due to the wildfire and whose principal residence was in the California wildfire disaster area. Qualified wildfire distributions, up to $100,000, are subject to income taxation but not the 10 percent early withdrawal penalty, and such amounts can be recontributed to a qualified plan within a three-year period following the distribution.
Plan Sponsor Impact and ActionPlan sponsors who wish to take advantage of these changes may permit participants to take immediate distributions; however, plan documents must be amended to reflect the new terms. The deadline for amending plans to include this relief is the last day of the first plan year beginning on or after January 1, 2019. Plans are not required to offer this disaster-related relief.
Employers and plan sponsors should also inform participants of the disaster-related relief available, should they decide to amend their plans to allow for it.