Proposed IRS Regulations Affecting 401(k) and 403(b) Plans [Podcast]
In this episode of the Proskauer Benefits Brief, Paul Hamburger co-chair of Proskauer’s Employee Benefits & Executive Compensation Group, and associate Steven Einhorn discuss the recently proposed IRS regulations addressing the hardship withdrawal rules affecting 401(k) and 403(b) plans. We will discuss challenging questions employers and administrators face as they work through the new requirements, which include the elimination of the six-month contribution suspension for participants who take a hardship withdrawal and how many plans will need to be amended as a result of these new proposed regulations.
Steven Einhorn: Hello and welcome to the Proskauer Benefits Brief. I’m Steven Einhorn, an attorney in Proskauer’s Employee Benefits and Executive Compensation Group and on today’s episode I’m joined by Paul Hamburger, Co-Chair of our Employee Benefits and Executive Compensation Group. As we all know, the IRS recently issued proposed regulations addressing the hardship withdrawal rules affecting 401(k) and 403(b) plans. We have summarized those rules in a separate blog entry available on Proskauer’s Employee Benefits and Executive Compensation Blog. You can find our blog at www.erisapracticecenter.com or with the link in the show notes.
In this podcast we will address some of the more challenging questions facing employers and administrators as they work through the new requirements. Paul, one thing we are hearing a lot from clients about is the elimination of the six-month contribution suspension for participants who take a hardship withdrawal. Can you tell us more about this change?
Paul Hamburger: Sure. Thanks, Steven. Under existing rules the IRS requires that if a participant takes a hardship withdrawal the participant must suspend all future contributions pre-tax, post-tax or other kinds of contributions to the plan and other similar plans for a six‑month period. Plans are permitted to eliminate that contribution suspension for plan years beginning on or after January 1, 2019. So the rule now would no longer require that the plan suspend employee contributions to the plan as a consequence of taking the hardship withdrawal.
Now, since that rule is effective for plan years beginning on or after January 1, 2019, the question arises as to what happens for people who are in the middle of a suspension period because they might have taken a hardship withdrawal within six months of the end of 2018? And the IRS has a proposed regulation that would allow plans to end the suspension period effective as of January 1, 2019 if they want to, so you don’t need to continue any suspensions beginning into the 2019 plan year.
Steven Einhorn: So, Paul, plans are allowed to remove the suspension requirement beginning with the 2019 plan year, but are plans required to remove the suspension requirement?
Paul Hamburger: No, for 2019 plan years, the plan can choose whether or not to continue to impose the suspension. In our experience we’re finding that more clients are actually eliminating the suspension, albeit voluntarily than not. However, come January 1, 2020 and I mean for distributions on or after January 1, 2020, the suspension rule goes away. That is then going to be the required date to eliminate the hardship suspension.
Steven Einhorn: Ok, so plan sponsors who are listening to this, they’ll understand that they need to change some provisions regarding their hardship distributions, but what’s actually involved with these changes?
Paul Hamburger: First and foremost, employers and administrators really need to coordinate with record keepers. You need to understand where the record keeper is coming from, a number of record keepers have best practices that they are using as far as when they will eliminate the suspension period and when they won’t. Separately, you’ll need to consider plan amendments and we’ll talk more about the due date in a minute. Also you’ll want to make sure that you update any participant communications, such as Summary Plan Descriptions (SPDs) or other forms of communication. For example, safe harbor notices for 401(k) plans may describe the hardship distribution rules, and if you’re giving a notice in December of 2018 for 2019 you may want to make sure that references to the suspension period are eliminated if the plan chooses to eliminate the suspension period.
Steven Einhorn: When we think about these changes we generally think about defined contribution plans, plans such as 401(k) plans and 403(b) Plans. However, one thing that you and I have discussed is that it’s also interesting to consider the possible indirect impact that these rules will have on nonqualified deferred compensation plans, plans that are subject to code Section 409A.
Paul Hamburger: That’s right, Steven; when we talked about it an interesting issue arose as a result of participants having to suspend contributions to 401(k) plans as well as potentially non-qualified deferred compensation plans and there’s a rule in Code Section 409A that would allow for the termination of a deferral election in a non-qualified deferred comp plan as a result of somebody having taken a 401(k) hardship distribution. Well, once you no longer have to impose the suspension on 401(k) hardship distributions, it’s a fair question to ask whether you really need to cancel deferral elections under non-qualified deferred comp plans anymore. It just may be something you may want to get rid of, it might be something that you want to keep, but it’s definitely something that you’ll want to think about as you head into 2019.
Steven Einhorn: One item that’s found in the proposed regulations is a new rule that makes it easier to demonstrate that a hardship distribution is necessary to satisfy the participant’s need. Paul, can you explain those new rules?
Paul Hamburger: Under existing rules the way you demonstrate that your distribution, your hardship distribution, is going to satisfy the particular hardship need is by meeting one of two possible tests. One is a general facts and circumstances test where the participant demonstrates that they don’t have the availability of other assets; they’ve taken other available distributions and they meet certain other requirements.
A safe harbor test would simply: say did you take all other distributions and loans currently available to you and will you make a representation that the need is necessary, the amount is necessary to satisfy the need? Under the proposed regulations there’s now a single test, much simpler to meet. All that a participant has to do is take all other distributions that are available and then make an affirmative representation in writing or by electronic means that the participant had insufficient cash or liquid assets available to satisfy the need. That’s it, much simpler. Until 2020 this rule is voluntary about applying this new easier to meet standard.
However, beginning in 2020 participants must make this affirmative representation and this new rule will be fully enforced. Now, separately, Steven, I have a question for you. I know that the hardship distribution rules and the proposed regulations focus a great deal on 401(k) plans but aren’t there some unique twists for 403(b) plans?
Steven Einhorn: Yes, that’s right, there sure are. For the most part these new proposed regulations apply equally to both 401(k) plans and their 403(b) plans. So plan sponsors of either type of plans need to be paying attention to these new rules. But there’s a few differences in how these rules apply to 401(k) and 403(b) plans. Just one of the examples, under the new proposed regulations, earnings on a pre-tax elective deferral that’s made to a 401(k) plan can be available for a hardship withdrawal, but earnings on a pre-tax elected deferral to a 403(b) plan cannot be available for a hardship withdrawal. Tax exempt employers who sponsor a 403(b) plan should be paying attention to these rules and focusing on how some of these new rules are specific to 403(b) plans.
Changing gears now, Paul, there’s definitely some provisions in many plans that will need to be amended as a result of these new proposed regulations; but how quickly will plans need to be amended?
Paul Hamburger: Plans will need to consider possible amendments. The good news is you don’t have to amend the plans right away, there will be time. The proposed regulations say that the outside deadline for amending plans would be the end of the second calendar year after the IRS issues a required amendments’ list including these potential changes. Essentially the earliest time that plans would have to amend under this rule would be by the end of 2021, so there’s plenty of time to consider and make the changes but now is probably a good idea to think administratively about what you want to do so that when you ultimately do the amendments they will reflect your actual practice.
Steven Einhorn: Thanks for these thoughts, Paul. There certainly are a lot of issues to consider when implementing these new rules. If listeners would like to obtain more information on the proposed regulations, please click on the link to our blog entry on the topic which is found in the show notes. Thank you for joining us today on the Proskauer Benefits Brief. Stay tuned for more legal insight on employee benefits and executive compensation and be sure to follow us on iTunes.