Compliance Alert: The New Hardship Regulations are Here!

As you may be aware from our prior Top of Mind blog entry, the Bipartisan Budget Act of 2018 (more commonly known as the tax reform bill) changed a number of hardship distribution provisions, effective 1/1/2019, that would be applicable to all plans that permit distributions on account of hardship (which are the vast majority of 401(k) and 403(b) plans out there). However, the tax reform bill left us with a lot of questions that required IRS action to resolve. Fortunately, on November 9, 2018, the IRS issued proposed regulations that will tell plan sponsors exactly how to administer the new hardship rules, which the bill did not address.

It appears that the regulations addressed the following critical areas that were unclear when the tax reform bill was issued:

  1. The six-month suspension of elective deferrals requirement for hardship distributions has indeed been eliminated, effective in 2019. Since we are so close to year-end, the regulations will not necessitate that this suspension requirement be eliminated until January 1, 2020, though plans can be amended as early as January 1, 2019. If a plan sponsor wants the suspensions to be eliminated on 1/1/2019, what happens if a hardship distribution is taken in the last six months of 2018? It appears that the IRS will give plan sponsors a choice as to how to wish to handle those distributions: They can either end all such suspensions on 1/1/2019 or allow such suspension to continue for the full six months.
  2. Effective in 2019, earnings on 401(k) elective deferrals may now be distributed for hardship. Previously, only the deferrals themselves, and not earnings, could be distributed. But due to differing regulations, earnings will not be available for distribution in 403(b) plans. This came as somewhat of a surprise (well, to me at least), since I thought that the IRS would have some leeway here since the tax reform bill was unclear as to how 403(b) earnings would be treated. (See my PLANSPONSOR Ask the Experts column for details in this regard.)
  3. There is no longer a requirement that all loans from all retirement plans sponsored by the employer be taken prior to a hardship distribution being available. (All other available distributions under the employer’s plans must be taken, though.) However, many plan sponsors view such a provision as desirable, since it minimizes plan leakage. Unfortunately, the proposed IRS regulations appear to eliminate the safe harbor protection for plans that opt to continue to require that all outstanding loans be exhausted before a hardship distribution is taken. However, this requirement also has a delayed effective date, so that the current safe harbor can continue to be relied upon until January 1, 2020.
  4. Though the tax reform bill now permits plan sponsors to allow hardship distributions from QMACs and QNECs, as well as qualified automatic contribution arrangement (QACA) contributions if they wish, the 403(b) rules restricting hardship distributions from custodial accounts (more commonly known as mutual funds) have not changed. (For the uninitiated, QMACs and QNECs are special contributions that are used primarily to correct nondiscrimination testing failures, and QACA contributions are made in a type of automatic enrollment.) Thus, if QMACs/QNECs/QACAs have ever been invested in a custodial account, they would not be eligible for a hardship distribution.

In addition to these clarifications, the proposed regulations also addressed the changes to the hardship rules that were specified in the tax reform bill and previous legislation, as follows:

  1. Profit-sharing/stock bonus contributions are now eligible for hardship withdrawal.
  2. Hardship distributions for medical, educational and funeral expenses may include those incurred by the primary beneficiary under the plan.
  3. Hardship distributions for casualty losses due to property damage may be taken and it does not matter whether the damage was due to a federally declared disaster. (There was some uncertainty about this due to a change in the regulations regarding deductibility of casualty losses.)
  4. Hardship distributions may be taken as the result of the declaration of certain disasters, such as certain recent hurricanes.
  5. Plan sponsors may elect to allow hardship distributions for the new reasons described in items 2, 3 and 4 above as early as 1/1/2018.
  6. Participants must self-certify that they have insufficient cash/liquid assets necessary to satisfy the need for which they are taking the hardship distribution. Thus, self-certification is sufficient to process a hardship distribution unless the plan administrator has actual knowledge to the contrary. However, this self-certification requirement is not effective until January 1, 2020. (A plan sponsor may require such self-certification earlier than 1/1/2020 if it wishes.)

Of course, these are just proposed regulations, so it is possible that the final version of the regulations may differ. In addition, this analysis is based on our initial read of the proposed regulations, and it is possible that alternate interpretations of the regulations may surface. Thus, you should make certain that you are signed up for our newsletters and Compliance Alerts, and that you follow me on Twitter for up-to-the minute information on these proposed regulations!

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Michael A. Webb is a Vice President at Cammack Retirement Group.

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. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.

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