IRS Publishes Final Regulations Regarding Hardship Distributions:

On September 23, 2019, the IRS published final regulations governing financial hardship distributions from 401(k) plans and 403(b) plans. As background, while a participant in one of those plans is working for the plan sponsor, his or her ability to withdraw money from the plan is quite limited. One of the permissible in-service distribution events is a financial hardship. If a plan allows hardship distributions, then to qualify for this type of withdrawal:

  • A participant must experience an immediate and heavy financial need. To simplify administration, many plans use certain safe harbors. Under those rules, distributions for six types of expenses (e.g., certain medical expenses) have historically been deemed to be made because of an immediate and heavy financial need.
  • The distribution amount cannot exceed the amount necessary to satisfy that need (plus amounts necessary to pay taxes or penalties reasonably anticipated to result from the distribution). Per a safe harbor, under which a distribution has historically been deemed necessary to satisfy the financial need: (1) a participant must first obtain all currently available distributions and nontaxable plan loans from the plan before receiving a hardship distribution; and (2) such participant cannot make contributions to the plan for at least six months after receiving the hardship distribution.   
  • Historically, the maximum amount that can be distributed via a hardship distribution has generally been limited to participants’ contributions that have not previously been distributed, excluding related investment earnings.

The final regulations reflect the following law changes:

  • The six-month suspension of participants’ contributions after their receipt of a hardship distribution will not be permitted. This rule is optional for the 2019 plan year and mandatory for hardship distributions received on or after January 1, 2020.
  • The maximum amount available for a hardship distribution is limited to elective deferrals, QNECs, QMACs, and safe harbor contributions, including earnings on those contributions. This rule is optional, starting with the 2019 plan year. However, two nuances apply to 403(b) plans. First, QNECs and QMACs that are not in a custodial account can be distributed on account of hardship, but QNECs and QMACs that are in a custodial account continue to be ineligible for distribution on account of hardship. Second, earnings attributable to elective deferrals continue to be ineligible for distribution on account of hardship. 
  • Participants do not have to take an available plan loan before taking a hardship distribution. This rule is optional, starting with the 2019 plan year.
  • The regulations previously permitted a hardship distribution for a “casualty loss” as defined under Internal Revenue Code (“Code”) section 165.  The Tax Cuts and Jobs Act of 2017 (the “Act”) changed  the Code section 165 casualty loss provision by requiring that the loss be incurred due to a federally-declared disaster. The final regulations clarify that the Act’s change does not apply to hardship distributions. Thus, a hardship distribution for expenses to repair damage to a participant’s principal residence (i.e. a casualty loss) need not be connected to a federally-declared disaster. This provision is mandatory for hardship distributions received on or after January 1, 2020.

As another optional plan provision, starting with the 2019 plan year, the final regulations add a new type of expense to the safe harbor list of expenses that are deemed to constitute an immediate and heavy financial need: expenses incurred as a result of certain federally-declared disasters (e.g., such as flooding, hurricanes, wildfires).

In addition, permitted for the 2019 plan year but required starting on January 1, 2020,the final regulations change the provisions for determining whether a distribution is necessary to satisfy a financial need. For hardship distributions made on or after January 1, 2020, the historical “relevant facts and circumstances” test is eliminated. That test is replaced with a more objective test.

Under that new test: (1) a hardship distribution cannot exceed the amount of the participant’s need; (2) the participant must first obtain other available distributions under the plan; and (3) the participant must represent (in writing or via an electronic medium) that he or she has insufficient cash or liquid assets “reasonably available” to satisfy the financial need. With respect to that third prong, an employer can rely on a participant’s representation unless the employer has actual knowledge to the contrary.

As for plan amendments incorporating applicable provisions of the final regulations:

  • Individually-Designed Plans:  These plans will have to be amended by the end of the second calendar year that begins after the issuance of the IRS’s Required Amendments List that includes the regulations’ provisions.
  • Pre-Approved Plans:  Sponsors of these plans will have to adopt an amendment by the later of the plan sponsor’s tax filing deadline (including extensions) for the tax year in which the plan amendment is effective or the last day of the plan year in which the amendment is effective. For example, a plan that first implements the prohibition on elective deferral suspensions in 2020 could use the required amendment deadline (i.e. the tax-filing deadline plus extensions for 2020) as the deadline for an amendment that adds the new safe harbor expense category (which the plan actually could have implemented in 2018). 
  • 403(b) Plans:  The amendment deadline is currently March 31, 2020. Per the final regulations’ Preamble, however, the IRS might provide a later amendment deadline for provisions addressing these final regulations.

Here is a link to the final regulations: