Background

Generally, in-service distributions from a 401(k) plan or a 403(b) plan are prohibited. However, if the plan’s terms permit, a participant may take an in-service distribution from his or her retirement account because of a “financial hardship” if the withdrawal follows the guidelines issued by the Internal Revenue Service (“IRS”). Last Fall, the IRS published proposed regulations describing changes to the rules governing hardship distributions and making it easier for participants to take hardship distributions starting this year. Last week, the IRS finalized those regulations with minor changes (the “Final Regulations”). Plans that implemented changes in accordance with the proposed regulations will satisfy the Final Regulations.

Summary

The final hardship distribution rules:

  1. eliminate the requirement that employee deferral contributions be suspended for at least six months following a hardship distribution;
  2. permit plans to eliminate the requirement that a participant first exhaust all available plan loans before taking a hardship distribution;
  3. provide a general standard for determining whether a distribution is “necessary” under which the employee must first have obtained all other available non-hardship distributions under the employer’s plans and based on the employee’s representation that the employee has insufficient cash or other liquid assets to meet the financial need;
  4. with an exception for 403(b) plans described below, expand the contributions and earnings that are eligible to be withdrawn in a hardship distribution to include the following contribution sources: qualified non-elective contributions (“QNECs”), qualified matching contributions (“QMACs”), safe harbor matching and non-elective employer contributions, and earnings on all such contributions, including post-1988 earnings on 401(k) deferrals; and
  5. expand the list of deemed hardship events to include federally declared disasters and clarify hardship distributions related to other casualty losses. The new hardship distribution event allows a participant to take a hardship distribution due to expenses and losses (including loss of income) incurred after federally-declared disasters if the participant’s home or principal place of business at the time of the disaster was located in an area designated for federal assistance. The IRS will no longer publish specific disaster relief announcements with specific deadlines by which a disaster-related hardship must be requested. For future disasters, distributions will not be available for expenses and losses related to the employee’s relatives and dependents.

A Note to 403(b) Plan Sponsors

The changes to the hardship distribution rules generally apply to 403(b) plans as well. However, there are two notable exceptions.

  • Post-1988 earnings on 403(b) elective deferrals (and QNECs and QMACs to the extent attributable to elective deferrals) continue to be ineligible for hardship distributions, and
  • QNECs and QMACs and other employer contributions held in a custodial account continue to be ineligible for hardship distributions.

The only mandatory changes under the Final Regulations are the elimination of the six-month contribution suspension and the employee-representation requirement, both of which are effective January 1, 2020. Any suspensions on deferral contributions in effect because of a distribution taken in 2019 may be lifted effective January 1, 2020. Alternatively, the plan sponsor may continue to apply the original suspension for the remainder of its term. All other changes are permissive. Any changes, including the mandatory changes, made must be evidenced by a plan amendment.

The deadline for amending an individually designed plan is the last day of the second calendar year that begins after the year in which the IRS’s Required Amendments List first includes these requirements. For example, if the 2019 Required Amendments List published by the IRS includes these requirements, the related plan amendments would have to be made by December 31, 2021. The IRS has not yet issued a Required Amendments List that includes these changes. However, we expect they will be on the next list that will be issued in late 2019.

What Employers Should Do Now

Sponsors of plans that currently use the six-month contribution suspension must eliminate the suspension and implement the required employee representations contemplated by the Final Regulations no later than January 1, 2020. Plan sponsors that implemented these changes effective January 1, 2019, do not have to make further changes now.

Additionally, all plan sponsors should consider whether to make the changes that are permitted, but not required, by the new rules. Plan sponsors should consult with their plan recordkeepers and third-party administrators to make sure that the changes to be made pursuant to the Final Regulations are timely implemented and with their legal advisors to ensure that changes are timely communicated to plan participants and any required plan amendments are timely adopted.