Does your company sponsor a 401(k) or 403(b) plan? Are you a plan administrator or trustee of a plan? Are you a participant in one of these plans? Do you want your plan to be in compliance with IRS regulations? If you answered yes to any of the above questions, this article will be extremely important to you.
The Bipartisan Budget Act, issued in February 2018, changed the hardship distribution provisions. The recently issued final IRS regulations included a few changes from the initial proposed regulations. The entire text of the regulations can be found in the Federal Register, which is cited at the end of this article, but below are the key components related to hardship withdrawals.
Hardship distributions can be allowed to meet immediate and heavy financial need for…
Purchase of a principal residence
Payment of tuition, fees and room and board
Payments necessary to prevent eviction from or foreclosure on the mortgage of a principal residence
Burial or funeral expenses
Repair of damage to a principal residence meeting the definition of a casualty under IRC Section 165
Expenses and losses incurred from FEMA-designated disasters (most recent addition)
Also note, the final regulations were modified from the proposed regulations by defining a “primary beneficiary under the plan” as an individual for whom qualifying medical, educational, and funeral expenses may be incurred.
Establishing a financial need:
Plan participants are not required to obtain plan loans before becoming eligible for a hardship distribution. Previously participants were required to exhaust all other options before obtaining a hardship withdrawal which included obtaining a plan loan if the plan offered loans.
A participant must provide the plan administrator with a representation that he or she has insufficient cash or other liquid assets available to satisfy the hardship. The plan administrator must also not have actual knowledge that contradicts the representation, which can be made in writing, (including using an electronic medium), or in other prescribed forms, which includes verbal representations.
Sources of withdrawal:
Hardship distributions are now allowed to draw from qualified non-elective contributions (QNECs), qualified matching contributions (QMACs), elective deferral contributions and earnings on those contributions. The regulations clarify that safe harbor matching and nonelective contributions are included in the definition of QNECs and QMACs and are eligible sources. A Plan may limit the sources available for hardship distributions, but these sources are not automatically precluded. Previously, plans generally were not allowed to distribute funds derived from QNECs, QMACs, or income earned on elective deferrals.
Suspension of contributions:
The initial proposed regulations removed the previously required six-month suspension of deferral contributions after receipt of a hardship withdrawal. The prohibition on suspension applies only to qualified plans (i.e. section 401(k)), section 403(b), and section 457(b). The final regulations clarify that a Plan subject to IRC Section 409A (nonqualified deferred compensation plans) may still impose a suspension provision in the plan but is not required to. Before these new regulations, a six-month suspension of deferrals had to be applied to a participant’s account upon receipt of a hardship distribution.
If, on or after January 1, 2020, a hardship withdrawal includes money sourced from matched employee contributions, a suspension of employee contributions is not permitted.
These 401(k) regulations apply to section 403(b) plans as well with minor exceptions. QNECs and QMACs in a 403(b) plan that are in a custodial account are ineligible for hardship distribution as the applicable 403(b) code section was not amended.
Effective dates and amendments:
Changes to the hardship distribution rules made by the BBA are effective for plan years beginning after December 31, 2018. There are numerous options available for plan sponsors for applicability dates in the final regulations for various situations (See the regulation for additional details).
It is expected that plan sponsors amend their plan’s hardship provisions beginning no later than January 1, 2020 to reflect the final regulations.
The amendment deadline for a 403(b) plan is March 30, 2020, but there is current consideration of a later deadline which will be clarified in a separate guidance.
Next steps for your compliance with the new regulations:
Review your plan document with your third-party administrator, legal counsel, and plan management.
Determine if the plan will apply the optional provisions and determine if the plan will apply certain provisions before the mandatory applicable dates.
Make the necessary plan amendments and participant communications.
Take this opportunity to evaluate your current process for hardship withdrawals, such as documentation and approval, and determine if modifications are needed to comply with federal regulations and the terms of the plan.
The new regulations generally make it easier for participants to obtain hardship withdrawals. Plan sponsors will need to ensure their plans are in compliance with the most recent IRS regulations.
E. Cohen & Company, CPAs is a full-service CPA firm, located in Rockville, Maryland that has a specialty in employee benefit plans. If you are in need of third-party administration services, plan advising, an audit of your plan, form 5500 preparation, or have general inquiries regarding the new regulations or existing regulations, please reach out to Phillip Mills, CPA at firstname.lastname@example.org. We look forward to developing a solution that best fits your needs.