On November 16, 2012, the IRS released Announcement 2012-44, which expands access to plan loans and hardship distributions for victims of Hurricane Sandy. This alert discusses who is eligible for relief and outlines procedures plan administrators may follow when making distributions.
The Internal Revenue Code permits participants in 401(k) and certain other defined contribution plans access to the dollars in their accounts during employment in limited circumstances. One circumstance is that defined contribution plans may authorize plan loans, allowing participants to borrow money from their accounts and pay it back over time. Another is that 401(k) and 403(b) plans may provide their participants with the option to receive distributions on account of hardship. Similarly, 457(b) plans may provide participants with the option to receive distributions because of unforeseen emergencies.
These standards are sometimes difficult to meet. A hardship, for example, requires an immediate and heavy financial need, and the distribution from the retirement account must be necessary to satisfy the need. Plans often limit hardship withdrawals to narrow IRS “safe harbor” reasons, such as for the purchase of a principal residence, to prevent eviction from a principal residence, for funeral expenses, for postsecondary education expenses and for expenses for the repair of damage to a participant’s principal residence. None of the safe harbor hardship reasons would cover damages caused by Sandy to automobiles, boats or second homes.
Expanded Access to Loans and Hardship Distributions
The IRS Announcement provides that 401(k), 403(a) and 403(b) plans, as well as 457(b) plans maintained by state and local government employers, can make hardship distributions or distributions because of an unforeseen emergency for any need arising from Hurricane Sandy.
A plan that does not currently permit loans or hardship distributions but is capable of making loans or hardship distributions if it contains enabling language can make such loans or hardship distributions to Hurricane Sandy victims. Plan sponsors that wish to add hardship distribution or loan features to help victims of Hurricane Sandy may do so without first amending their plans. However, by the end of the first plan year beginning after December 31, 2012, plan sponsors will have to amend their plans to reflect actions taken to help Hurricane Sandy victims.
Distributions can be made to any current or former employee whose principal place of residence or place of employment on October 26, 2012, was in a covered disaster area or to any current or former employee whose spouse, dependent, descendant or ascendant lived or worked in a covered disaster area on that date. Covered disaster areas include parts of New York, New Jersey, Connecticut and Rhode Island.
Loans and hardship distributions must be made on or after October 26, 2012, and no later than February 1, 2013. A defined benefit or money purchase plan may make hardship distributions pursuant to the Announcement only if the distributions are from separate accounts within the plan funded by employee contributions or rollover amounts.
Plans that make distributions to Hurricane Sandy victims pursuant to the Announcement are not required to enforce rules prohibiting participants from making contributions to a plan for at least six months following a hardship distribution.
Other limits on distributions remain in effect. Hardship distributions cannot be made from qualified non-elective contribution accounts, qualified matching contribution accounts or earnings on elective contributions, and any limits on a hardship distribution’s amount still apply. Plan loans must comply with Internal Revenue Code Section 72(p).
Procedures for Distributing Loans and Hardship Distributions
When determining if an employee or former employee has a need for a hardship distribution and the amount the employee needs, plan administrators can rely on representations from the employee or former employee. A plan administrator cannot rely on these representations, however, if the plan administrator has actual knowledge that the representations are false.
Further, a retirement plan can make loans and hardship distributions to Hurricane Sandy victims before full compliance with the plan’s procedural requirements, after the plan administrator has made a good-faith, diligent effort to comply with the plan’s requirements. For example, under the Announcement, a plan that requires spousal consent for a loan and requires a death certificate to prove a spouse is deceased can waive the death certificate requirement if it would be reasonable to believe the spouse has died. However, after the loan is made, the plan must make a reasonable effort as soon as practical to obtain the death certificate.
The IRS has eased access to plan loans and hardship distributions for needs resulting from Hurricane Sandy. Plan administrators should be familiar with the Announcement’s provisions as employees and former employees seek access to retirement accounts to pay for needs resulting from the storm.