As Congress negotiated the legislation that ended up as The Tax Cut and Jobs Act (“Jobs Act”) and the Bipartisan Budget Act of 2018 (“Budget Act”), it considered significant changes to employer based retirement plan rules. However, very few of these were included in the final versions of these acts. One set of changes that did become law were to the rules that apply to hardships distributions from Internal Revenue Code (“Code”) Section 401(k) and 403(b) retirement plans.
Although not required by law, a retirement plan may allow a participant to receive a hardship distribution from the participant’s elective deferral contribution, discretionary employer contribution and regular matching contribution accounts (and the earnings on these contributions made before December 31, 1988), but only if the distribution is due to an immediate and heavy financial need and is limited to the amount necessary to satisfy the financial need.
A plan may provide that the plan administrator will made an individualized determination of whether a hardship distribution satisfies these standards or it can provide for a regulatory safe harbor under which a distribution is automatically considered to be necessary to satisfy an immediate and heavy financial need if all of the following requirements are met:
- The distribution isn’t greater than the amount of the immediate and heavy financial need, including amounts necessary to pay any taxes resulting from the distribution.
- The employee has obtained all other currently available distributions and nontaxable plan loans.
- The employee isn’t allowed to make elective deferrals to the plan for at least six months after the hardship distribution.
In addition, a plan may provide that an employee is automatically considered to have an immediate and heavy financial need if the distribution is for any of these purposes:
- Medical care expenses for the employee, the employee’s spouse, dependents or beneficiary.
- Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments).
- Tuition, related educational fees and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents or beneficiary.
- Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.
- Funeral expenses for the employee, the employee’s spouse, children, dependents, or beneficiary.
- Certain expenses to repair damage (casualty) as to the employee’s principal residence.
Changes Under the Jobs Act and Budget Act
Elimination of Six-Month Suspension Rule – The Budget Act eliminated the requirement that a participant who takes a hardship withdrawal must suspend elective deferrals for at least six months. As a result, a plan may permit a participant who receives a hardship distribution to continue to make elective deferral contributions to his or her plan account following receipt of the hardship withdrawal. The elimination of the six-month suspension rule applies for plan years beginning on or after January 1, 2019.
Elimination of Plan Loan Requirement – The Budget Act also eliminated the requirement under the automatic need safe harbor that a participant must have taken all available plan loans. Plans may implement this change for plan years effective on or after January 1, 2019.
Expanded Contribution Sources – The Budget Act permits an employer to expand the contribution sources from which a participant may take a hardship distribution to include qualified non-elective employer contributions (QNECs), qualified matching contributions (QMACs), and all earnings. The new rule applies to plans for plan year beginning on or after January 1, 2019.
Casualty Loss Safe Harbor – The Jobs Act amended the Code to provide that personal casualty losses are deductible to a taxpayer only to the extent such losses are attributable to a federally declared disaster. This change applies to losses incurred in tax years beginning after December 31, 2017 and before January 1, 2026.
The new law could limit the circumstances under which the automatic need safe harbor will apply to expenses incurred to repair damage caused by a casualty loss. Due to the change in when expenses to repair a casualty loss are deductible, expenses to repair damage caused to a principal residence by a fire or storm for example, would not qualify as a hardship distribution under the safe harbor unless the fire or storm is part of a federally declared disaster.
Plan Sponsor Action
Plan sponsors should consider whether to amend their plans to eliminate the six-month suspension and plan loan rules and/or to expand the contribution sources from which hardship distributions may be taken, beginning in the 2019 plan year. In addition, plans sponsors should immediately consult with their record keepers to determine whether the method of administering hardship distribution requests based on a personal residence casualty.