On September 23, the IRS published final regulations on hardship distributions in the
Federal Register. Although there are some changes and clarifications, the IRS described the final regulations as “substantially similar” to the proposed regulations in the Federal Register on November 14, 2018. The following is our summary of the changes that apply to 401(k) plans, as well as John Hancock’s perspective on how to proceed with both the mandatory and optional provisions.
Seven 401(k) hardship withdrawal rule changes and what to do next
1. Removing the six-month deferral suspension
The new rule eliminates the suspension period, which prohibited participants who took a hardship withdrawal from making new contributions to the plan for six months.
Status: Required for all plans, effective January 1, 2020
Our point of view: Plans need to comply with the removal of the suspension period for all hardships requested on or after January 1, 2020. Plan sponsors may want to consider reinstating all participants on suspension prior to January 1, 2020, to permit them an opportunity to rebuild their savings sooner. However, plan sponsors should consult their recordkeepers to see if this creates any operational challenges or results in any additional costs.
2. Removing the requirement that a principal residence casualty loss be caused by a federally declared disaster
The Tax Cuts and Jobs Act of 2017 modified the Internal Revenue Code (I.R.C.) Section 165 to limit deductions for casualty losses to those associated with federally declared disasters. However, under the hardship distribution rules, it had the unintended effect of limiting casualty losses to federally declared disasters. This provision corrects that situation.
Status: Required for all plans that used safe harbor hardship events, effective January 1, 2020
Our point of view: All plan sponsors should consider removing the requirement that a casualty loss be attributable to a federally declared disaster, which created an unfortunate roadblock for some participants during a time of financial need.
3. New uniform hardship withdrawal standards
Under this provision, participants must certify that they have insufficient cash or other liquid assets to satisfy the hardship before being allowed to make a withdrawal.
Status: Required for all plans, effective January 1, 2020
Our point of view: The ability to rely on a participant’s certification absent of a plan administrator’s actual knowledge to the contrary protects the plan and plan fiduciaries, thus, reducing potential liability.
4. Expanding the amount available for withdrawals to include earnings on elective deferrals
This change would permit all account earnings, including earnings on elective deferrals after 1988, for hardship withdrawal.
Our point of view: Since most participants consider earnings on their pretax or Roth deferrals to be part of their deferral subaccount, it makes sense to make them available for hardship withdrawal.
5. Expanding the amount available for withdrawals to include employer contributions
Adding this provision makes previously excluded types of employer contributions available for hardship withdrawal. These include qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and both matching and nonelective safe harbor contributions.
Our point of view: Plan sponsors should consider not expanding the available withdrawal amount to include QNECs, QMACs, or safe harbor contributions. Since 401(k) plans are established mainly for providing retirement savings, participants shouldn’t be provided the ability to withdraw all their funds while still employed, at least prior to reaching age 59½.
6. Eliminating the requirement to take a plan loan
By implementing this provision, plans no longer require that available plan loans be taken before a hardship withdrawal is allowed.
Our point of view: Plan sponsors should consider continuing to require that a plan loan be taken prior to a hardship withdrawal. Loans are repaid to the plan, while hardship withdrawals aren’t. Thus, in the long run, it may be more beneficial to participants to take a plan loan.
7. A new hardship event for federally declared disasters
This provision adds a new safe harbor event to address participant expenses and losses (including loss of income) incurred due to federally declared disasters.
Our point of view: Plan sponsors should consider adopting the new hardship event for federally declared disasters. The IRS will no longer issue special disaster-relief announcements to permit hardship distributions to those affected by specific federally declared disasters.
Important things to know as you update your 401(k) hardship provisions
As you update your 401(k) plan’s hardship withdrawal provisions, you’ll want to keep these points in mind.
For pre-approved plans (those with prototype and volume-submitter documents), the IRS has generally extended the deadline for amendment adoption to the due date of the plan sponsor’s tax return (with extension). For individually designed plans, the deadline is two years after publication of the final regulations on the IRS’s Final Amendment List. Talk with your plan consultant about specific timing.
401(k) plans that permit hardship distributions will need to be in operational compliance by January 1, 2020.
Plan sponsors that previously acted in response to the proposed regulations should review prior plan amendments and administrative changes to confirm operational and plan document compliance with the final hardship regulations.
The new rule requires only that a distribution not exceed what a participant needs, and that the participant certifies that they lack enough cash to meet their financial needs. Participants can make a representation that they have insufficient cash or other liquid assets reasonably available to satisfy a financial need, even if they actually have those assets on hand, provided the assets are earmarked to pay for an upcoming obligation, such as rent. Self-certifications can be made over the phone—provided the call is recorded and the final rule is clarified during the call—or can be made in writing or by email.
The above-mentioned participant certification is in addition to, and doesn’t replace, the substantiation requirement (including the requirement to provide source documentation if requested by the IRS).
Federally declared disasters
The new hardship event for federally declared disasters is different than previously available after the IRS issued separate guidance for each disaster. Specifically, this new hardship event covers only losses incurred by the participant, with no time limitation on when the hardship distribution must be requested and no special extended deadline for amending the plan after the disaster to include this hardship event.
The final regulations clarify that a plan subject to I.R.C. Section 409A (i.e., nonqualified deferred compensation plans) may retain its deferral suspension provision or, to the extent consistent with Section 409A and other applicable rules, remove the provision by way of amendment.
Earnings on 403(b) contributions will remain ineligible for hardship withdrawals due to a statutory prohibition that Congress didn’t remove with the Bipartisan Budget Act of 2018.
The good news is that you may already have a jumpstart on implementing these changes. In releasing the new hardship rules, the IRS confirmed that plans already in compliance with last fall’s proposed regulations will satisfy final regulations as well.
Finally, as you consider your strategy for communicating your updated hardship withdrawal policies and procedures, don't forget to emphasize the continued importance of emergency savings. In most instances, personal savings will be a better choice for covering unforeseen expenses than a retirement plan withdrawal.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date but may be subject to change. John Hancock and its representatives do not provide investment, tax, or legal advice. Please consult your own independent advisor as to any investment, tax, or legal statements made herein.
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