The Bipartisan Budget Act of 2018 (BBA) mandated changes to
the 401(k) hardship distribution rules. Generally, these changes relax certain
restrictions on taking a hardship distribution. For 2019, the changes are
optional, but effective January 1, 2020, following issuance of final regulations,
certain changes will be mandatory.
An employer may, but is not required to, provide for
hardship distributions in their retirement plans. Many plans such as 401(k)
plans, 403(b) plans, and 457(b) plans permit hardship distributions.
If a 401(k) plan provides for hardship distributions, it must provide the specific criteria used to make the determination of hardship. Thus, for example, a plan may provide that a distribution can be made only for medical or funeral expenses, but not for the purchase of a principal residence or for payment of tuition and education expenses. In determining the existence of a need and of the amount necessary to meet the need, the plan must specify and apply nondiscriminatory and objective standards.
The rules for hardship distributions from 403(b) plans are similar to those for hardship distributions from 401(k) plans. If a 457(b) plan provides for hardship distributions, it must contain specific language defining what constitutes a distribution on account of an “unforeseeable emergency.”
Effective for hardship withdrawals made on or after December 31, 2018, IRS proposed regulations eliminate the mandatory requirement that a participant obtain all loans available under the plan and all other plans maintained by the employer. Such a restriction is now an optional provision that may be adopted by the employer. The requirement that a participant must first obtain available distributions under all other plans maintained by the employer, (whether qualified or nonqualified) before receiving a hardship withdrawal remains in place.
Hardship distributions from a 401(k) plan were previously
limited to the amount of the employee’s elective deferrals and generally did
not include any income earned on the deferred amounts. The proposed regulations
permit, but do not require, 401(k) plans to allow hardship distributions of
elective contributions, QNECS, QMACS, and safe harbor contributions and
earnings on these amounts regardless when contributed or earned. The change can
be made as of January 1, 2019.
The proposed regulations also make it optional for 2019 to
prohibit an employee from making elective contributions and employee
contributions to the plan and all other plans maintained by the employer for at
least 6 months after receipt of the hardship distribution. Under the proposed
regulations effective January 1, 2020, the 6-month suspension from making
elective contributions is no longer allowed.
Prior to the issuance of the proposed regulations there were
no special rules for hardship distributions on account of hurricanes or other
natural disasters. The proposed regulations modify the safe harbor list of
expenses for which distributions are deemed to be made on account of an
immediate and heavy financial need by adding a new type of expense to the list,
relating to expenses incurred as a result of certain disasters.
Finally, the proposed regulations incorporate guidance
provided under the Pension Protection Act of 2006 by providing that qualifying
medical, educational, and funeral expenses relating to a participant’s primary
beneficiary may qualify as expenses eligible for a hardship withdrawal.
A review of these changes would indicate that employers
should not wait until 2020 to make these changes because they represent opportunities
for employers to simplify plan administration in areas where administrative
mistakes often occur.
Plan participants should ask their employers about the implementation
and timing of these changes so they can adjust their financial plans