Ice Miller LLP: Insights

Are You Ready? Proposed Regulations Regarding Hardship Distributions

As noted in our prior e-alert (restated below), the Internal Revenue Service ("IRS") has issued proposed regulations regarding hardship distributions from 401(k) and 403(b) plans. For some of the key provisions, the plans must operationally comply with the proposed regulations beginning on January 1, 2020. For any optional provisions implemented in 2019, the affected plans must be amended by December 31, 2019. For the mandatory plan provisions, although they must be implemented by January 1, 2020, the affected plans have until at least the second calendar year that begins after the issuance of the Required Amendments List ("RAL") that includes the change to amend the plan document.

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To reflect the change in federal law, the IRS has updated the "Retirement Plans FAQs regarding Hardship Distributions," available at https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-hardship-distributions.

Hardship distributions, if allowed by the plan, permit plan participants access to funds when they are dealing with "an immediate and heavy financial need" while employed. The proposed regulations are in line with the IRS' plan to focus on implementation of the Tax Cuts and Jobs Act ("TCJA") and the Bipartisan Budget Act of 2018 ("Budget Act").

The Treasury Regulations under Internal Revenue Code ("Code") §§ 401(k) and 403(b) provide rules for determining when a financial hardship distribution is permitted. The distribution must be made on account of an "immediate and heavy financial need," and the distribution must be necessary to satisfy the financial need. The Regulations provide safe harbor rules so a plan may determine whether the hardship withdrawal regulations have been satisfied. Without the safe harbor rules, the plan must determine, on the basis of individual facts and circumstances, (1) whether the need is immediate and heavy and (2) whether it is necessary for the participant to have the funds withdrawn to satisfy the need.

Expansion of Safe Harbor Rules for Immediate and Heavy Financial Need

Expands list of qualifying expenses. The safe harbor rule for determining whether there is an “immediate and heavy financial need” permits a distribution to be made on account of one of the following financial needs:

medical care described in Code § 213(d) for the employee, the employee's spouse or the employee's dependents (regardless of whether the expenses exceed 7.5% of adjusted gross income;
costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);
payment of tuition, related educational fees, and room and board expenses, for up to the next 12 months of postsecondary education for the employee, the employee's spouse, children, or dependents;
payments necessary to prevent the eviction of the employee from the employee's principal residence or to prevent foreclosure on the mortgage on that residence;
payments for burial or funeral expenses for the employee's deceased parent, spouse, children or dependents; or
expenses for the repair of damage to the employee's principal residence that would qualify for the casualty deduction under Code § 165 (determined without regard to whether the loss exceeds 10% of adjusted gross income).

The proposed regulations expand this list of expenses for which hardship distributions are deemed to be made "on account of an immediate and heavy financial need."

Adds primary beneficiaries. If the participant's medical, educational or funeral expenses are incurred for the participant's "primary beneficiary under the plan," those expenses now fall into the safe harbor definition, regardless of whether the primary beneficiary is the participant's spouse, child or dependent.

Adds expenses incurred as a result of certain disasters. Expenses incurred as a result of certain natural disasters are added to the safe harbor rule. The preamble provides that the intent is “to eliminate any delay or uncertainty concerning access to plan funds following a disaster that occurs in an area designated by the Federal Emergency Management Agency (FEMA) for individual assistance.” Plans may allow for the new safe harbor effective any time after January 1, 2018, if the plan is properly amended.

Additionally, in the preamble, the IRS extended relief relating to Hurricane Maria and California wildfires provided in Announcement 2017-15 to similarly situated victims of Hurricanes Florence and Michael, except that the “Incident Dates” (as defined in that announcement) are as specified by FEMA for these 2018 hurricanes. Relief is provided through March 15, 2019.

Restores casualty loss safe harbor. Prior to the passage of the TCJA, Code § 165 included personal losses from a range of occurrences. The TCJA limited casualty loss deductions under Code § 165 to those attributed to a federally-declared disaster. The proposed regulations modify the safe harbor to disregard this change made by the TCJA. As a result, damage to a principal residence that would qualify for a casualty deduction under § 165 does not have to be in a federally declared disaster area.

Changes to Hardship Distribution Requirements Following the Budget Act

The Budget Act provided that a participant shall not be treated as failing to meet the requirements of a hardship "solely because the employee does not take any available loan under the plan." The Budget Act also directed the Treasury Secretary to amend regulations interpreting Code § 401(k) to eliminate the six-month suspension period for making new contributions following a safe harbor hardship distribution.

The proposed regulations eliminate any requirement that a participant be prohibited from making employee contributions after receipt of a hardship distribution (for distributions made on or after January 1, 2020) and remove the requirement that a participant must take available plan loans prior to receiving a hardship distribution. In fact, the proposed regulations prohibit plans from suspending participants from making contributions. This prohibition is mandatory only for distributions made on or after January 1, 2020.

The Budget Act also permitted participants to take hardship withdrawals from participant elective deferrals, qualified non-elective contributions, qualified matching contributions and the earnings on those contributions. The proposed regulations implement this provision of the Budget Act. However, plans may continue to limit the contribution sources available for hardship distribution. Importantly, this item was not changed for 403(b) plans. The Budget Act did not amend Code § 403(b)(11) to allow for hardship distributions of elective deferrals. In addition, qualified non-elective contributions and qualified matching contributions held in a custodial account continue to be ineligible for hardship distributions.

New Standard for Determining Whether Hardship Exists

As mentioned above, if a plan does not rely on the safe harbor hardship rules, the plan administrator must determine, on the basis of individual facts and circumstances, whether the need is immediate and heavy and whether it is necessary for the participant to have the funds withdrawn to satisfy the need. The proposed regulations eliminate the facts and circumstances test and replace it with a three-part general standard. The standard would require that:

the hardship distribution not exceed the amount of a participant's need (including any amounts necessary to pay any taxes or penalties reasonably anticipated to result from the distribution),
the participant must have obtained other available distributions under the employer’s plans before taking the hardship distribution, and
the participant must represent that he or she has insufficient cash or other liquid assets to satisfy the financial need. As with the current standard, a plan administrator may rely on a participant’s representation of the need unless the plan administrator has actual knowledge to the contrary.

Plan administrators may begin applying this standard on January 1, 2019, but the requirement to obtain a participant’s representation becomes mandatory for hardship distributions made on or after January 1, 2020.

Because these are still proposed regulations, there are no required deadlines to amend plan documents.
However, as the preamble points out, Rev. Proc. 2016-37 provides that the deadline for amending the plan to reflect a change in qualification requirements is the end of the second calendar year that begins after the issuance of the Required Amendments List that includes the change.

Should you have questions about hardship distribution requirements or would like to discuss possible plan amendments in light of these proposed rules, please contact Audra Ferguson-Allen, Robert Gauss, Lisa Harrison, Lindsay Knowles, Tara Sciscoe, Chris Sears or the Ice Miller LLP Employee Benefits attorney with whom you most closely work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.