IRS Proposes Regulations Expanding Certain Tax-Qualified Retirement Plans Hardship Withdrawals Opportunities and Relaxing Certain Related Requirements
SynopsisDistributions from tax-qualified retirement plans are generally not permitted prior to the participant’s separation from service with the employer sponsoring the plan. (Failure to comply with this requirement can result in the disqualification of the plan for tax purposes.) An exception from this limitation has been available where a Section 401(k), 403(b), or 457(b) retirement plan provides for participant elective deferral contributions and permits “hardship withdrawals” from the plan accounts to which these contributions are credited. A hardship withdrawal must be on account of an immediate and heavy financial need of the plan participant, which cannot be met by the participant’s other resources, including insurance. Certain medical, educational, and funeral expenses, and certain costs relating to the purchase or repair of, or to prevent eviction from, the participant’s principal residence will generally qualify. Compliant hardship withdrawals provide a potential source of funds for certain financial emergencies, and although they are taxable to the plan participant upon receipt, they do not jeopardize the plan’s tax-qualified status. Under recently-issued IRS proposed regulations, effective for plan years beginning after 2018, certain opportunities to receive hardship withdrawals are expanded, and certain existing hardship withdrawal-related requirements are relaxed.
DetailsUnder the Bipartisan Budget Act of 2018, certain expansions to and relaxations of the hardship withdrawals rules (which were proposed as part of the House bill for the Tax Reform and Jobs Act of 2017, but were not included in the final Tax Cuts and Jobs Act of 2017), have now become law, effective for 2019 plan years. In conformance with these changes, IRS proposed regulations were recently issued, which include the following:
Expansion of plan accounts and contribution sources eligible for hardship withdrawals:Currently, only participant elective deferral contributions are eligible for hardship withdrawals. Under the proposed regulations, in addition, for 2019 and after, hardship withdrawals will also be available from employer qualified non-elective contributions (QNECs), qualified matching contributions (QMACs) and earnings from any of these accounts. However, this change was not made applicable to earnings attributable to elective deferral contributions made under a Section 403(b) plan.
Plan loans no longer required:Currently, as a requirement for obtaining a hardship withdrawal, a plan participant must first exhaust all available plan loan opportunities. Under the proposed regulations, this requirement is eliminated, and, for 2019 and after, no plan loan will be required as a condition for receiving a hardship withdrawal. A plan can impose such a requirement for distributions occurring prior to 2020; however, after 2019, such a requirement will not be permitted.
Six-month moratorium on participant contributions eliminated:Currently, once a participant receives a hardship withdrawal, the participant is precluded from making elective deferral contributions to the plan for a period of six months. Under the proposed regulations, this requirement is eliminated, and, for 2019 and after, no participant elective deferral contribution suspension will be required for a participant who takes a hardship withdrawal from the plan. A plan can impose such a requirement for distributions occurring prior to 2020; however, after 2019, such a requirement will not be permitted.
Expansion of safe harbor expenses:
For 2019 and after, the proposed regulations expand the existing safe harbor list of expenses for which distributions are presumed to be made on account of an immediate and heavy financial need, as follows:
- Medical, education and funeral expenses of the “primary beneficiary” under the plan will qualify (i.e., in addition to those of the plan participant).
- For expenses incurred for damage to the participant’s principal residence that would qualify for a casualty deduction under IRC Section 165, the Section 165(h)(5) limitation (i.e., only to the extent attributable to a Federally declared disaster) and the 10% of adjusted gross income threshold will not apply.
- Expenses incurred as a result of FEMA-declared disasters will qualify if the participant’s principal residence or principal place of employment is located within an area designated by FEMA for individual disaster assistance.
Unified standard as to whether a distribution is necessary to satisfy a financial need?Post-2018, the proposed regulations replace the “relevant facts and circumstances” standard for determining whether a distribution qualifies for a hardship withdrawal, with a single standard, namely, that (1) the amount of a hardship distribution may not exceed the amount of the plan participant’s need (including any amounts necessary to pay any federal, state or local income taxes or penalties reasonably anticipated to result from the distribution), (2) the plan participant must have obtained other available non-loan distributions under the employer’s plans, and (3) for distributions after 2019, the plan participant must provide the employer with a representation to the effect that he or she has insufficient cash or other liquid assets to satisfy the financial need.
What does CohnReznick think?Sponsors of Section 401(k), 403(b) and 457(b) retirement plans which offer hardship withdrawals should continue to educate their employees about these changes. Some plan participants who may currently be considering a hardship withdrawal may benefit from postponing the withdrawal until the beginning of their plan’s 2019 plan year. In addition, plan sponsors should consult with their legal counsel about the need to amend their plans and revise their summary plan descriptions and employee notices and distribution forms in connection with these changes. It is noteworthy, however, that regardless of the above-identified expansions and relaxations, ultimately a plan participant will still not qualify for a hardship withdrawal unless the participant first looks to his or her own cash and other liquid assets, and takes all non-loan distributions available from the employer’s plans.
For more information, or for assistance with other employee benefits or executive compensation inquiries, please contact Dana Fried, a CohnReznick National Tax Managing Director, at firstname.lastname@example.org or 516-417-5064.
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JD, LLM, Managing Director - National Tax Services
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