United States: IRS Proposes Simplifying And Expanding Hardship Distributions

On Friday, November 9, 2018, the IRS issued proposed amendments to the regulations relating to hardship distributions from 401(k) plans.  The amendments primarily reflect changes made by the Tax Cuts and Jobs Act and the Bipartisan Budget Act of 2018.

Proposed Regulations.  The proposed regulations, which would generally be effective for plan years beginning on and after January 1, 2019, would simplify hardship administration and expand the scope of hardship distributions.  Highlights of the proposed regulations include:

  • Plans could allow hardship distributions of all earnings on elective contributions. Currently only earnings on elective contributions accrued before 1989 are eligible for hardship distributions.
  • Plans could allow hardship distributions from qualified nonelective contributions ("QNECs") and qualified matching contributions ("QMACs").
  • Plans would no longer be required to suspend a participant from making employee contributions for at least 6 months after taking a hardship distribution.

    • On the first day of the plan year beginning on or after January 1, 2019, plan sponsors may end any existing suspensions imposed following hardship distributions taken in the plan year beginning in 2018.
  • Participants would not be required to take available plan loans before obtaining a hardship distribution.
  • With respect to distributions made on or after January 1, 2018, the proposed regulations clarify that for purposes of hardship distributions related to damage to a principal residence that would qualify for a casualty loss deduction, the Tax Cuts and Jobs Act restriction that the loss be attributable to a federally declared disaster does not apply.
  • The proposed regulations add to the list of safe-harbor hardship expenses any expenses or losses (including lost income) incurred due to a federally declared disaster if the employee's principal residence or principal place of employment is in an area designated by the Federal Emergency Management Agency ("FEMA") as eligible for individual assistance.

    • This expansion is consistent with the IRS's past administrative practice of granting relief from hardship standards following natural disasters such as hurricanes and wildfires.  Note, however, that the proposed regulations do not address the relaxed hardship documentation requirements that has typically accompanied the IRS's federally declared disaster relief.

Changes are Initially Optional.  The changes made by the proposed regulations would generally be optional.  For example, a plan sponsor could choose not to allow hardship distributions of QNECs and QMACs or to adopt the expanded safe-harbor expenses.  However, for plan years beginning on or after January 1, 2020, plans may not require that participants take loans before obtaining hardship distributions or require that participants be suspended for a least 6 months after taking a hardship distribution.

Next Steps and Timing of Amendments.  Plan sponsors may operate their plans in accordance with the proposed regulations beginning on the first day of the plan year beginning on or after January 1, 2019. The deadline for adoption a corresponding plan amendment would be no earlier than December 31, 2021.

Many recordkeepers have already begun the process of implementing changes based on the statutory provisions and are soliciting decisions from their client plan sponsors.

We expect that most sponsors will choose to immediately eliminate the loan and suspension requirements and to allow the expanded distributions of earnings on elective contributions.  The added safe-harbor expenses were not widely expected, so there may be some delay before recordkeepers can make the necessary system changes, but we expect that most plans will eventually add those safe harbors.

We expect that fewer sponsors will opt to allow hardship distributions of QNECs and QMACs.  This is partly because many plans limit hardships to the participant's own deferral contributions, and partly because many sponsors do not regularly make QNECs or QMACs.

Relief Related to Hurricanes Florence and Michael.  In the preamble to the proposed regulations, the IRS announced that the hardship relief provided in Announcement 2017-15 (related to Hurricane Maria and the 2017 California Wildfires) based on the incident dates specified by FEMA is available for eligible individuals affected by Hurricanes Florence and Michael through March 15, 2019.  For more information on the hardship relief available, please see our prior HRBenefitsAuthority, dated September 13, 2017 discussing the relief provided by the IRS following Hurricane Irma.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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