Employee Benefits Alert

The Internal Revenue Service (IRS) has finalized revisions to the regulations governing hardship distributions under 401(k) and 403(b) plans. The final regulations make some subtle but important changes to the regulations that were issued in proposed form in 2018 (discussed in our previous alert) and provide some helpful clarification on how and when the final regulations apply. This article discusses those changes, summarizes other guidance and reminders in the final regulations, and lists the various effective dates and amendment deadlines for the final regulations.

Notable Changes

  • Employee representation requirement relaxed. The proposed regulations required that (effective for distributions on or after January 1, 2020) a participant make a representation that he or she has insufficient cash or other liquid assets to cover expenses resulting from a hardship. The final regulations relax this requirement by providing that the participant must represent only that he or she has insufficient cash or other liquid assets reasonably available to cover expenses resulting from a hardship. The IRS explained that, as revised, an employee could represent that he or she meets such requirement even though the participant may have some cash on hand, provided that cash is earmarked for another obligation in the near future, such as rent. Plan sponsors who adopted the revised hardship regulations as originally proposed may wish to further amend their plans to incorporate this relaxed standard.
  • Prohibition on six-month suspension does not apply to unfunded nonqualified plans. The current regulations impose a mandatory six-month suspension on deferrals made by a participant who receives a hardship distribution under all qualified and nonqualified plans maintained by the employer. The proposed regulations prohibited such a suspension but did not state the plans to which this prohibition applied. The final regulations provide that the prohibition on any suspension of deferrals applies to qualified plans, section 403(b) plans, and eligible 457(b) plans, but it does NOT apply to unfunded nonqualified plans such as those generally subject to Code Section 409A and the regulations thereunder. Plan sponsors of nonqualified plans may want to review their plans to determine whether the suspension will be retained or, to the extent consistent with Code Section 409A and the regulations thereunder, removed.
  • Employee representations by email, telephone, and website are acceptable. The proposed regulations stated that the mandatory employee representation regarding the need for a hardship distribution could be made “in writing, by an electronic medium, or in such other form as may be prescribed by the Commissioner.” In response to a question of whether recording telephone representations was acceptable, the IRS revised the final regulations to define “electronic medium” by reference to Treasury Regulation 1.401(a)-21(e)(3). Under such regulation, an “electronic medium” is “an electronic method of communication (e.g., website, electronic mail, telephonic system, magnetic disk, and CD-ROM).” Plan administrators who self-administer hardship distributions may want to establish an electronic process for receiving employee representations such as through email or an intranet site.

Helpful Guidance and Reminders

  • Expenses incurred as a result of a natural disaster. The IRS highlighted the following differences between this new safe harbor expense category and ad hoc relief that had previously been provided by the IRS in response to certain major federally declared disasters: (1) Only expenses and losses of an employee who lived or worked in the disaster area qualify under the new safe harbor expense category. Under the prior disaster-relief announcements, expenses and losses of an employee’s relatives and dependents could also qualify for hardship distributions. (2) Unlike the disaster-relief announcements, there is no specific deadline following the disaster during which a hardship distribution must be requested under the revised regulations. (3) Unlike the disaster-relief announcements, there is no extended deadline for plan sponsors to add disaster-related distribution or loan provisions to the plan under the revised regulations. However, the IRS is considering separate guidance to address delayed amendment deadlines when the new safe harbor expense or loan provisions are added to a plan at a later date in response to a particular disaster. The IRS does not anticipate issuing any further disaster-relief announcements in regards to hardship distributions.
  • Requirement to not have “actual knowledge” that an employee’s representation is false. The IRS clarified that this requirement does not mean that plan administrators must inquire about a participant’s financial condition. Rather, an administrator should just not have actual knowledge that the representation is false through “sufficiently accurate information” it already possesses.
  • Additional conditions that may be imposed (including minimum dollar amount). In response to a question as to what additional conditions a plan could impose on a hardship distribution, the IRS provided the following examples: (1) completion of a plan’s application process; (2) provision of any required documentation; and (3) a non-discriminatory minimum dollar amount.
  • Safe harbor notices may need to be updated. Both the proposed and final regulations expanded the types of contributions that may be subject to a hardship distribution to include qualified nonelective contributions (QNECs) and qualified matching contributions (QMACS) (which includes safe-harbor nonelective and matching contributions) for 401(k) plans. The IRS noted that a safe harbor 401(k) plan adopting this expansion will generally have to update its safe harbor notice because the required description of withdrawal provisions in such a notice would no longer be accurate. Any mid-year change to a safe harbor will need to comply with Section III.C of Notice 2016-16.

Mandatory and Permissive Effective Dates (for a Calendar Year Plan)

Amendment Deadlines

  • Individually designed 401(k) plans - December 31, 2021 (assuming the final regulations are included in the 2019 Remedial Amendment List)Amendment Deadlines
  • Pre-approved 401(k) plans - Generally, the sponsor’s tax-filing deadline (plus extensions) for the 2020 tax year
  • 403(b) plans - March 31, 2020; however, the IRS is considering providing for a later amendment deadline