The Internal Revenue Service (IRS) has announced relief to retirement plan participants impacted by Hurricane Sandy. The IRS relief relaxes the rules for hardship withdrawals and loans from certain tax-qualified plans for participants requiring plan withdrawals and loans as a result of Hurricane Sandy. Hurricane Sandy-related hardship withdrawals must be made (1) on account of a hardship resulting from Hurricane Sandy, (2) on or after October 26, 2012, and (3) no later than February 1, 2013. The relief does not require employers to offer Hurricane Sandy-related hardship withdrawals or loans, but permits employers who wish to do so to make Hurricane Sandy-related hardship withdrawals and loans available to employees affected by Hurricane Sandy without imposing certain restrictions otherwise imposed on hardship withdrawals and loans.

Background

IRS rules governing tax-qualified plans place restrictions on the permissibility of in-service plan withdrawals and loans. Tax-qualified plans may only permit in-service withdrawals (such as hardship withdrawals) and loans to participants in limited situations. Hardship withdrawals and plan loans are only permitted from certain types of retirement plans, including 401(k) savings and 403(b) plans. In general, hardship withdrawals are only permitted if:

  • the plan document specifically provides for hardship withdrawals;
  • the withdrawal is made on account of an immediate and heavy financial need and the amount must be necessary to satisfy the financial need;
  • the plan provides the specific criteria used to make the determination of hardship (many plans limit hardship withdrawals to certain enumerated events, such as payments necessary to prevent eviction from, or foreclosure on, a principal residence, payments for certain medical expenses, costs relating to the purchase of a principal residence and payments for burial or funeral expenses);
  • the participant has no other resources available to meet the need, including assets of the participant's spouse and minor children (this requirement can be deemed satisfied if the participant has obtained all other currently available distributions and loans under the employer's plans);
  • participants are prohibited from making contributions after receiving the hardship withdrawal for at least six months; and
  • certain verification and documentation procedures are followed.

If a tax-qualified plan provides for participant loans, the maximum amount that the plan may loan to a participant is (1) the greater of $10,000 or 50% of the participant's vested account balance, or (2) $50,000, whichever is less, in each case subject to a reduction for the difference between the highest outstanding loan balance in the past 12 months and the outstanding balance of the participant's loans from the plan on the date of the new loan. Loan repayments must occur within five years (ten years if the loan is for the purchase of the participant's principal residence) and payments must be made in substantially equal payments that include principal and interest and that are paid at least quarterly. Unlike hardship withdrawals, which require a demonstration of specific types of need, the purpose of the loan or the participant’s ability to borrow the same amount elsewhere is generally irrelevant in determining whether the loan is permitted.

IRS Hurricane Sandy Relief

The IRS relief allows certain tax-qualified plans to make hardship withdrawals and loans available to participants under relaxed rules if the need for the withdrawal or loan arises on account of a hardship resulting from Hurricane Sandy. To qualify for such relief, the participant taking the hardship withdrawal or loan (or such participant's child, parent, grandparent, other dependent or spouse) must have had a principal place of residence or employment on October 26, 2012 in one of the geographic locales that has been designated by the Internal Revenue Services as a covered disaster area. These include various counties in New York, New Jersey, Connecticut and Rhode Island. To be an eligible Hurricane Sandy-related hardship withdrawal, the hardship withdrawal must be needed as a result of Hurricane Sandy and must be made on or after October 26, 2012 and no later than February 1, 2013.

Plan administrators may rely on the representations of the participant as to the need for and amount of a hardship withdrawal related to Hurricane Sandy, unless the plan administrator has actual knowledge to the contrary. An eligible plan that currently does not provide for hardship withdrawals or loans is permitted to make hardship withdrawals or loans related to Hurricane Sandy pursuant to the IRS guidance.

The amount of a Hurricane Sandy-related hardship withdrawal is limited to the maximum amount that would be permitted for an ordinary hardship withdrawal under the Internal Revenue Code. However, unlike regular hardship withdrawals, participants will not be prohibited from making plan contributions for six months following the hardship withdrawal.

If a tax-qualified plan makes Hurricane Sandy-related hardship withdrawals or loans, the plan document must be amended to provide for such hardship withdrawals or loans by the end of the first plan year beginning after December 31, 2012 (that is, December 31, 2013 for calendar year plans).

The Department of Labor has advised the Treasury Department and IRS that it will not treat any person as having violated ERISA solely because of compliance with this recent IRS guidance.

As of the date of this client alert, no specific relief has been provided for the 10% penalty that may otherwise apply to hardship withdrawals taken by plan participants who are under age 59 1/2.

Additional details may be found in IRS Announcement 2012-44.