If you are one of those plan sponsors who was waiting for the final hardship regulations to be issued before making any changes to hardship distributions in your plans – your time has come. The Treasury Department and IRS issued the final regulations on September 19, 2019 for publication today, September 23, 2019.
These regulations finalize the proposed regulations issued on November 14, 2018, and they are essentially the same with some clarifications. Plans that made changes in compliance with the proposed regulations will be deemed to have complied with the final regulations. Overall the rules – which generally apply to 401(k) plans, 403(b) plans, and 457(b) plans – ease some of the restrictions on taking hardship distributions.
The changes are effective for distributions beginning no later than January 1, 2020. Nearly all plans will need to be amended for the changes if they haven’t been already; if employers already made amendments, they should review to see if they need any clarifications. The amendment deadline will depend on when the change appears on the Required Amendments List the IRS issues each fall. If it appears on the 2019 List – which is likely – then employers must adopt amendments for calendar year plans no later than December 31, 2021. Earlier deadlines may apply for pre-approved plans such as prototypes, and for 403(b) plans.
Most of the changes are optional. The most important required change is that plans can no longer automatically suspend participant contributions following a hardship distribution. The reason for this change was so that participants can replace these funds since, unlike loan distributions that must be repaid, the only way to replace the hardship distribution funds is via contributions. This means that if a participant wants to stop contributions after the hardship, the participant would need to affirmatively do that.
The final regulations clarify that although employers cannot suspend contributions in their 401(k) plans, they can continue to do so under their nonqualified deferred compensation plans if provided under those plans.
The other main changes are optional:
- Plans do not have to require a participant to take a loan before taking a hardship distribution. We have heard that the change may be resulting in more hardship distributions. Some employers may want to retain the loan requirement, especially because unlike loans, hardship distributions are taxable and cannot be repaid to the plan. The employee still must take any other available, non-hardship distributions under the employer’s plans (including any ESOP dividends that are currently available to elect in cash).
- New types of account sources can be made available for hardship distributions: qualified matching contributions (QMACS) and qualified nonelective contributions (QNECs) (including employer safe harbor contributions), and earnings on deferrals and other eligible contributions. This rule has limited application in 403(b) plans.
- A plan can now allow hardships to employees who lived or worked in a federal disaster area. The final rules explain how this reason differs from the ad hoc disaster relief announcements the IRS has made in the past, which the IRS states this is intended to replace. The new guidance also updates and clarifies the safe harbor rules for previous law changes on casualty losses, and hardship distributions related to expenses of a participant’s beneficiaries. A plan will still be considered to use the safe harbor hardship standards even if the plan elects not to add all of the safe harbor reasons, or to not allow hardship distributions with respect to the participant’s beneficiary.
In addition, the final regulations require changes in the administrative process for determining whether a participant has demonstrated a financial need for hardship. Under the new rules, an employee requesting a hardship must provide a representation – written or electronic (including via telephone) – that he or she has insufficient cash or other liquid assets available to satisfy the financial need, and a hardship distribution cannot be made if the plan administrator has actual knowledge to the contrary. However, assets are considered only if they are reasonably available; for example, assets earmarked for payment of another obligation such as rent are not reasonably available. Plans can still add other requirements, such as a nondiscretionary minimum dollar amount.
Plan sponsors who haven’t yet made the changes should do so now, and all plan sponsors need to amend their plan documents by the deadline. Plan sponsors may also need to modify other plan communications such as annual notices to reflect the new rules.