On November 14, 2018, the Internal Revenue Service published Proposed Regulations in the Federal Register changing the rules for Hardship Distributions from 401(k) and 403(b) plans. IRS is accepting comments and Requests for Public Hearing over a 60-day period through January 14, 2019. While these regulations are proposed and not final, some involved in this process have stated they do not anticipate major changes.
The updates in the Proposed Regs incorporate legislative changes from the Tax Cuts and Jobs Act of 2017 (“TCJA”), the Bipartisan Budget Act of 2018 (“BBA”), and at least one going back to the Pension Protection Act of 2006 (“PPA”). Most changes are effective January 1, 2019 (Plan years beginning after 12/31/2018), although a few may electively be made effective sooner, while a few others are not mandatory until 2020.
To follow the changes, it’s helpful to keep in mind that for plans using the Safe Harbor Hardship Provisions (very widely used) Plan Administrators are required to 1) determine there is an immediate and heavy financial need, which is done by limiting Hardships to certain types of expenses and 2) determine the amount distributed is not more than needed (In the past this was done by asking questions about a participant’s financial situation, assets and loans).
The changes listed below are Proposed. ASPPA, and probably others, are already preparing requests for clarifications which should be forthcoming. For now, and for issue awareness, it is good to be aware of changes.
- 1. The Proposed Regulation states Hardship distributions for medical, educational or funeral costs may now be processed for a Participant’s Primary Beneficiary. As in the past these may continue to be processed for a Participant, Spouse, or Dependent of the Participant. (Note: PPA enacted this change in 2006, and plans were amended then. This is to align the regulations with underlying law.)
- 2. The TCJA changed the definition of casualty losses by limiting casualty loss tax deductions only to principal residence losses and only when the President declares a disaster area. Previously anyone with principal residence casualty losses had a potential tax deduction without government declarations. The Regulation clarifies that for Hardship Distribution both the Presidential disaster declaration and the 10% of Adjusted Gross Income rule used for tax purposes do not apply for Hardships. A Participant with a casualty loss from property damage may simply apply. This generally takes effect 1/1/2019, but plan sponsors wishing to do so may execute amendments effective as early as 1/1/2018. Plans that have already approved 2018 Hardship Withdrawals under the old rules should amend by 12/31/2018.
- 3. In addition, expenses and losses, including loss of income, incurred by a participant from a natural disaster in an area designated by the Federal Emergency Management Agency (FEMA) for individual assistance are eligible to apply for a Hardship Distribution. The Regulations state this rule should eliminate delays while IRS or Congress acts should remove uncertainty about access to funds in these cases. Hardship distributions may be requested as soon as FEMA announces a Designated Disaster Area. Unlike recent years, IRS will not issue disaster-by-disaster announcements. This should speed things up and eliminate needs for Interim Required Amendments after each disaster.
- 4. Plan Sponsors are prohibited from suspending deferrals for 6 months following hardship distributions after 1/1/2020. Plan Sponsors may implement this in 2019 (The 1st day of the 1st Plan Year after 12/31/2018). Sponsors may choose, with an amendment, to implement this for Hardships funded in 2018 still in suspension into 2019.
- 5. Plan Sponsors will no longer be required to make employees take all available Participant Loans before approving a Hardship Distribution application. This change is not mandatory, though. Sponsors wishing to keep the old loan requirement may continue to require plan loans first. Plan Sponsors, are, however, required to make employees take all available non-hardship distributions before approving a Hardship Distribution application. (In some cases these non-hardship distributions might include rollover, profit sharing or in-service distributions.) This is effective 1/1/2020. Sponsors who wish to do so may adopt an amendment and implement the change in 2019.
- 6. Plan Sponsors will no longer put in the awkward position of having to ask about personal loans, cash balances, personal accounts, and other investments an employee might own to ensure Hardship Funds are actually necessary. Under the new rules, an Employer may simply rely on an Employee’s written or electronic representation that the funds are needed unless the Employer has knowledge to the contrary. This is effective 1/1/2020 and may be implemented earlier with an amendment.
- 7. Plan Sponsors who choose to may now expand Hardship-eligible Fund Sources to include Safe Harbor (or QACA) 401(k) Employer Contributions (3% Non-elective, Basic or Enhanced Match), QNECs, and QMACs, in addition to Employee Elective Deferral accounts. For these sources all cumulative investment earnings qualify as Hardship-eligible Funds. These expansions are not mandatory, however; plan sponsors not wishing to open all (or any) of these Fund Sources are not required to. Plan sponsors may restrict the sources available to a subset. For non-custodial 403(b) plans, the new funding sources can qualify as Hardship-eligible Funding Sources. For custodial 403(b) plans, however, these sources are not available. Because of different language in 403(b) law (i.e., statutory limitations) no 403(b) plans may include investment earnings as qualified plans may do. (To implement new fund sources will require configuration updates on recordkeeping platforms).
- 8. Disaster losses from Hurricane Florence starting 9/7/2018, primarily in North and South Carolina and from Hurricane Michael starting 9/8/2018, primarily in Florida and Georgia, are eligible for Hardship Distributions. Applications are permitted through 3/15/2019.
The Proposed Regs state Plan Amendments will be required, but for Pre-approved plans, which of course constitute the vast majority, they are silent. ASPPA has decided to send a Comment Letter, and one of their requests is for clarification on Amendment Deadlines.
In the meantime, prior IRS guidance on amendment deadlines for Pre-approved plans provide one set of rules for mandatory plan qualification provisions and another for discretionary changes an employer chooses to make.
- • For mandatory plan qualification provisions, a Sponsor doesn’t have to sign or adopt an amendment until the end of the 2nd calendar year after IRS lists the required change in its “Required Amendments List”. With the 60-day Comment Window, under these rules, the earliest required amendment date for mandatory provisions would be 12/31/2020.
- • For plans that operationally implement any discretionary changes, such as implementing a new provision earlier than required, an amendment must be signed and adopted by the last day of the plan year of the change. (For most plans this will be December 31.)
- 8. Disaster losses from Hurricane Florence starting 9/7/2018, primarily in North and South Carolina and from Hurricane Michael starting 9/8/2018, primarily in Florida and Georgia, are eligible for Hardship Distributions. Applications are permitted through 3/15/2019. Plans implementing discretionary changes in 2018 (earlier than mandated) would be required to adopt an amendment by 12/31/2018.
Generally, amendments can be executed earlier than these deadline dates.