United States: IRS Proposes Regulations Regarding Hardship Withdrawals

Last Updated: November 23 2018
Article by C. Erik Hawes

The US Internal Revenue Service has released proposed regulations requiring retirement plans to eliminate the six-month suspension for hardship withdrawals made on and after January 1, 2020, with the option to eliminate it earlier, and providing important clarifications for plan sponsors on other hardship requirements.

The Bipartisan Budget Act of 2018 (BBA 2018), signed into law on February 9, modified the US Internal Revenue Code (Code) to expand the types of contributions available for hardship withdrawals from retirement plans, and directed the Internal Revenue Service (IRS) to issue regulations by January 1, 2019, to eliminate the requirement for a six-month suspension on elective deferrals that is needed to meet the safe harbor hardship standards. However, plan sponsors were left with unanswered questions and uncertainty on the timing and details for implementing these changes.

On November 9, the IRS released proposed regulations, generally effective January 1, 2019, that provide important clarifications for plan sponsors and offer additional relief regarding hardship circumstances and other requirements. Most critically, under the proposed regulations, all plans must eliminate the six-month suspension for hardship withdrawals made on and after January 1, 2020, and plans can elect to eliminate the six-month suspension for hardships—even on existing hardships—as early as January 1, 2019.

Proposed Regulations

The proposed regulations include the following important clarifications and changes:

  • Elimination of Six-Month Suspension. All 401(k) and 403(b) plans—including safe harbor 401(k) plans—must eliminate the six-month suspension beginning with hardship distributions made during plan years beginning on and after January 1, 2020. While the elimination of the suspension was generally provided in BBA 2018, the proposed regulations expressly prohibit imposing the suspension as a condition of hardship withdrawals on and after that date, thereby eliminating all doubt as to whether a plan sponsor could choose to leave in place the six-month suspension as a means to discourage hardship withdrawals and minimize retirement plan leakage. Although all plans must eliminate the six-month suspension beginning January 1, 2020, plan sponsors can choose to eliminate the six-month suspension as early as plan years beginning on or after January 1, 2019 (which is important and helpful given that many plan sponsors already amended their plans to comply with BBA 2018). Moreover, the proposed regulations clarify that plan sponsors may eliminate suspensions that are in place as of December 31, 2018 (meaning that a six-month suspension for a hardship withdrawal taken in the second half of 2018 can be cut short as of January 1, 2019).
  • Reliance on Participant Representations Concerning Financial Need. BBA 2018 provided that participants would no longer be required to take available loans (commercial or plan loans) before electing a hardship withdrawal to satisfy the requirement that the hardship withdrawal is deemed necessary to satisfy the participant's financial need. The proposed regulations eliminate this requirement (although plans may choose to continue imposing it), but require that the participant take all available distributions under the employer's deferred compensation plans (whether qualified or nonqualified). Moreover, for any distribution made on or after January 1, 2020, the participant must provide a written representation that he or she has insufficient cash to satisfy the financial need, and the plan administrator may rely on such representation in the absence of actual knowledge that this is untrue. (Notably, the representation requirement further streamlines the hardship substantiation procedures.)
  • Expansion of Available Hardship Sources. BBA 2018 provided that earnings on elective deferrals, qualified nonelective contributions (QNECs), and qualified matching contributions (QMACs) would be available for hardship withdrawal. The proposed regulations provide an important clarification that this includes safe harbor 401(k) plan contributions (whether matching or nonelective).

    • Important Note for 403(b) Plan Sponsors: Although 403(b) plans generally follow the hardship rules applicable to 401(k) plans, the proposed regulations do not modify the 403(b) rules to permit withdrawal of earnings on 403(b) elective deferrals or QNECs/QMACs that are in custodial accounts. As a result, 403(b) plan sponsors will need to exercise care when amending their plans to comply with BBA 2018 and the proposed regulations.
  • Expansion of Existing Safe Harbor Circumstances. The IRS expanded the hardship withdrawal circumstances to include medical, educational, or funeral expenses of primary beneficiaries (beneficiaries with an unconditional right to receive all or a portion of the participant's account upon the participant's death). In addition, the proposed regulations continue to allow plans to deem a participant eligible for a hardship withdrawal for expenses related to the repair of a principal residence that qualifies for the casualty loss deduction under Code Section 165, without regard to the change made by the Tax Cuts and Jobs Act (which otherwise would have limited hardships for principal residence repairs to losses incurred in federally declared disaster areas beginning January 1, 2018).
  • New Safe Harbor Hardship Circumstances. The IRS also added a new hardship withdrawal circumstance that permits a participant to be deemed to have an immediate and heavy financial need for expenses or losses (including loss of income) incurred on account of a federally declared disaster if the participant's principal residence or principal place of employment is located in the area designated by the Federal Emergency Medical Agency for individual assistance at the time of the disaster.
  • Hurricanes Florence and Michael Relief. The IRS extended the same loan and hardship relief to participants adversely affected by Hurricane Florence and Hurricane Michael that was extended to participants adversely affected by Hurricane Maria or the California wildfires in IRS Announcement 2017-15 (reliance on employee representations regarding need and amount of hardship, temporary disregard of loan procedural requirements, etc.).

Next Steps

The proposed regulations oddly do not include a clear statement allowing reliance before they are finalized. Nevertheless, it is predicted that much of the substance of the proposed regulations is unlikely to be changed before being finalized. As a result, plan administrators that have not already done so may wish to consider implementing these changes for 2019 or start planning to implement them in 2020. Moreover, plan administrators that have already decided to implement these changes for 2019 may wish to review the changes and clarifications added by the proposed regulations, and plan sponsors that already amended their plan documents should review their amendments to ensure compliance with the proposed regulations.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

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