December 17, 2018

401(k) Hardship Distribution Changes Coming

Life is full of surprises that often are greeted with a smile and make people feel excitement and exhilaration. Surprise parties, an end-of-year bonus or a thoughtful gift can elicit this reaction. However, there are also unwelcome surprises that are approached with anxiety, frustration, and stress about how to manage through them. Examples include a medical issue, unexpected educational or other expense or even a transitional life event such as buying a home. While most only want the former, the reality is the latter will happen at some point. To help those facing the latter,  the IRS recently issued a Notice of Proposed Rulemaking for 401k/403b Hardship Withdrawals. The proposed regulations modify the list of qualifying events which can constitute a “heavy financial need” and allows a participant to make an immediate withdrawal. They also eliminate uncertainty about when hardship distributions are permitted. To help clients, prospects and others understand the changes and how it impacts their plan’s administration, Wilson Lewis has provided a summary of key details below.

What is a Hardship Distribution?

A hardship distribution is a withdrawal that a plan participant is permitted to take from a qualifying 401(k) or 403(b) plan to cover a heavy financial need. In order to qualify, a plan participant must meet the criteria for a heavy financial need established by the plan documents and IRS. Some examples of need include out-of-pocket medical expenses, the purchase of a home, or tuition expenses for the participant or their dependent. Depending on the plan and age of participant, there may be a 10% penalty for the withdrawal and the withdrawn amount would be subject to income tax.

Proposed Withdrawal Expense Changes

Many of the proposed changes in this category are designed to allow participants impacted by a natural disaster easier access to their funds to help manage unexpected recovery expenses.

• The safe harbor withdrawal amount is not limited to expenses that occur in a federal disaster area and allows for losses from natural disasters such as hurricanes, fires, earthquakes or other sudden and unexpected disasters. The proposal requires this change be retroactive for hardship withdrawals made in 2018.
• A new expense type has been added which accounts for costs incurred as a result of certain disasters in federally declared disaster areas in which the participant has a principal residence or place of employment. The proposal requires the change to be retroactive to January 1, 2018.
• Certain medical, educational or funeral expenses of a primary beneficiary in a plan will be considered safe harbor withdrawal expenses as mandated under the Pension Protection Act (PPA) of 2016. As with the other changes, this would also be retroactive to the beginning of 2018.

Safe Harbor Withdrawal Qualification

These proposed changes address whether a hardship withdrawal is necessary to satisfy an immediate and heavy financial need.

• There is an existing rule that prohibits plan participants from making an elective deferral for six months following a hardship distribution. The proposed regulations require this rule be eliminated for all hardship withdrawals made after January 1, 2020. Plans can make the change on the first day of the plan year on or after January 1, 2019.
• Currently, there is a regulation in place that requires participants to take all available plan loans from a qualifying plan before taking a hardship distribution. Under the proposed regulations, the requirement to take a loan prior to a hardship distribution is eliminated on January 1, 2019. However, plan sponsors have the option of retaining this requirement if they so choose.

One Other Important Change

Under current regulations, permission to make a hardship withdrawal is based on relevant facts and circumstances. The proposed regulations require using a general framework to determine when a withdrawal is permitted. Th guidelines require that the withdrawal cannot exceed the amount needed to address the hardship, the employee must have exhausted all other options under the plan and they must present documentation in writing that they don’t have the financial resources needed to satisfy the hardship. It’s important to note the last change will not be effective until January 1, 2020, but plan sponsors can implement it earlier if desired.

Contact Us

While these are simply proposed regulations, it does provide insight into the changes which are likely to come. Plan sponsors should consider reviewing their plan documents to identify where changes need to be made once the proposed regulations become final. If you have questions about these regulations or need assistance with a plan issue or your 401k audit, Wilson Lewis can help! For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.