Treasury Proposes New Regulations for Retirement Plan "Hardship Distributions"
The U.S. Department of the Treasury has issued new proposed regulations that provide more flexibility for 401(k) and 403(b) plan participants to access their retirement accounts in the event of a financial hardship, as directed by changes made earlier this year by the newly enacted Bipartisan Budget Act of 2018 (the Budget Act).
Participants in 401(k) and 403(b) plans have a limited ability to receive distributions before reaching age 59½ or terminating employment. One exception is for distributions made to satisfy an immediate and heavy financial need, known as ″hardship distributions." Prior to the Budget Act, a 401(k) and 403(b) plan could allow hardship distributions if the distribution was necessary to satisfy an immediate and heavy financial need, the participant obtained all other available distributions and loans from the plan, and the participant was prohibited from making employee contributions (including elective deferrals) to all plans of the employer for six months following the distribution.
Treasury regulations deem the following circumstances to constitute an "immediate and heavy financial need":
Medical expenses for the participant, his or her spouse, dependents, or beneficiary;
Costs related to the purchase of a participant's principal residence;
Tuition or related education fees and room and board expenses for the next 12 months of postsecondary education for the participant, his or her spouse, children, dependents, or beneficiary;
Payments that are necessary to prevent eviction or the foreclosure of the participant's principal residence;
Funeral expenses for the participant, his or her spouse, children, dependents, or beneficiary; and
Expenses to repair casualty losses incurred to the participant's principal residence.
The Budget Act instructed the Treasury Department to eliminate the requirement in the regulations that a participant exhaust plan loan opportunities before receiving a hardship distribution, as well as the six-month suspension period on making employee contributions following receipt of a hardship distribution. The new proposed Treasury regulations permit plans to remove the six-month suspension period beginning on the first day of a plan year beginning on or after December 31, 2018, but require all 401(k) and 403(b) plans to implement this change for distributions made on or after January 1, 2020. Plans may continue to require that a participant exhaust any available plan loans.
The regulations further clarify that a plan can be amended—effective with the start of the 2019 plan year—to eliminate any remaining time left on a participant's six-month suspension period for those who received a hardship distribution in the latter half of the 2018 plan year. For plan years beginning January 1, 2020, a participant must certify that he or she has insufficient cash or other liquid assets to satisfy the financial need. A plan has the option to require this certification for the 2019 plan year.
In addition, the Budget Act expanded the list of circumstances deemed to constitute an immediate and heavy financial need to include all expenses and losses incurred by a participant due to a disaster declared by the Federal Emergency Management Agency. This change may be applied as early as January 1, 2018. The regulations also expand the sources of contributions available for a hardship distribution from a 401(k) plan (but not from certain 403(b) plans) to include: safe harbor employer contributions under an automatic enrollment arrangement, qualified nonelective contributions, qualified matching contributions, and all earnings on elective deferrals.
The Tax Cuts and Jobs Act, enacted in December 2017, provides that the deduction for a personal casualty loss is only available to the extent that the loss is the result of a federally declared disaster. The proposed regulations allow plans to disregard this provision so that hardship distributions can be taken for any casualty loss.
All 401(k) and 403(b) plans that permit hardship distributions will be required to be amended to implement these changes. The amendment deadline will be the end of the second calendar year after the new regulations are finalized and listed on the IRS list of required qualified plan amendments.