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The Proposed Hardship Distribution Regulations: Some Misconceptions

The proposed hardship regulations were issued less than a month ago, but there already appears to be a lot of misunderstanding among plan sponsors and those who work with them.

Based on the numerous questions we’ve received these past few weeks, it appears that the biggest misconceptions are as follows:

  • Plan sponsors are NOT required to eliminate the provision that borrowing be exhausted in order to take a hardship distribution — While the preamble to the regulations made this somewhat confusing, the actual proposed regulations are quite clear (note that boldface is our emphasis):

    “(C) Additional conditions. A plan generally may provide for additional conditions, such as those described in 26 CFR 1.401(k)-1(d)(3)(iv)(B) and (C) (revised as of April 1, 2018) or, for distributions made before January 1, 2020, the representation described in paragraph (d)(3)(iii)(B) of this section, to demonstrate that a distribution is necessary to satisfy an immediate and heavy financial need of an employee. For example, a plan may provide that, before a hardship distribution may be made, an employee must obtain all nontaxable loans (determined at the time a loan is made) available under the plan and all other plans maintained by the employer. However, for a distribution that is made on or after January 1, 2020, a plan may not provide for a suspension of an employee's elective contributions or employee contributions as a condition of obtaining a hardship distribution.”

    Despite the clarity of the new regulations, some plan sponsors still seem to think that they need to eliminate the borrowing requirement. In fact, retaining a requirement that all loans be taken will result in fewer hardship distributions - which is arguably a good thing, since hardship distributions are difficult to administer and can have terrible consequences for employees.

  • Plan sponsors MUST eliminate the requirement to suspend elective deferrals for six months following a hardship distribution — Unlike the elimination of the loan requirement, which is optional, the elimination of the elective deferral suspension is mandatory. However, some plan sponsors appear to have confused this provision with the loan provision, assuming this provision is elective. Per the same section of the proposed regulations cited above (again, boldface is our emphasis), the six-month elective deferral suspension must be eliminated by January 1, 2020:

    “(C) Additional conditions. A plan generally may provide for additional conditions, such as those described in 26 CFR 1.401(k)-1(d)(3)(iv)(B) and (C) (revised as of April 1, 2018) or, for distributions made before January 1, 2020, the representation described in paragraph (d)(3)(iii)(B) of this section, to demonstrate that a distribution is necessary to satisfy an immediate and heavy financial need of an employee. For example, a plan may provide that, before a hardship distribution may be made, an employee must obtain all nontaxable loans (determined at the time a loan is made) available under the plan and all other plans maintained by the employer. However, for a distribution that is made on or after January 1, 2020, a plan may not provide for a suspension of an employee's elective contributions or employee contributions as a condition of obtaining a hardship distribution.”

    Also, while the six-month suspension of elective deferrals following a hardship distribution provision must be eliminated by January 1, 2020, it can be eliminated earlier. In fact, even suspensions currently in effect can be ceased on January 1, 2019. Though plan sponsors will want to check with their recordkeeper to confirm that they are able to administer this change that soon, since January 1st is less than a month away!
  • These regulations have no effect on 457(b) plans — It appears that some plan sponsors think that the proposed hardship regulations affect 457(b) plans; however, those plans do not even have a hardship provision. Instead, 457(b) plans have an “unforeseeable emergency” provision, which is quite different from a hardship provision, and is not addressed in the proposed regulations.

One final note: the regulations are proposed and not yet final. Comments on the proposed regulations are being accepted, and it is possible that some of them may result in changes to the regulations as they are finalized, hopefully during the first quarter of 2019. Stay tuned!

Have you been hearing about any other misconceptions regarding the hardship regulations? Feel free to share your feedback via Twitter or at info@cammackretirement.com.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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