IRS Issues Final Regulations on 401(k) Hardship Distributions

On September 23, 2019, the U.S. Department of Treasury, acting through the IRS, issued final regulations governing hardship distributions (also known as hardship withdrawals) taken from 401(k) retirement plans. Aside from some clarifying details, the final regulations are substantially similar to the proposed regulations that were issued in November 2018.

The changes contained in both the proposed and final regulations largely reflect amendments made by the Bipartisan Budget Act of 2018 (“BBA”) and other recent legislation. Among the more significant revisions, which are covered in greater detail in our previous blog, are the elimination of the former six-month suspension of deferrals requirement, along with the elimination of the previous requirement that participants take a plan loan prior to taking a hardship distribution. The final and proposed regulations also expand the list of safe-harbor expenses that are automatically deemed to constitute “hardship” for purposes of these types of distributions.

Clarifying Changes.

The final regulations predominantly clarify changes that first appeared in the proposed regs. Highlights of the provisions in the proposed regs that are clarified in the final regulations include the following:

Hardships Relating to Federally Declared Disasters.

The final regulations spell out the new safe-harbor hardship for expenses and losses that are incurred due to a federally declared disaster applies only to expenses and losses of an employee whose principal residence or place of employment is located within a federally designated relief area. In other words, losses of relatives and dependents of such an employee are not covered under the hardship distribution safe-harbor – even though these persons may be referenced under federal disaster relief announcements.
Please note: Under the safe-harbor, there is no explicit deadline for requesting a disaster-related hardship distribution, nor is any particular procedural requirement set forth or suggested.

COMMENT: A little more guidance in this regard might have been helpful.

“Funds Available.”

In response to comments received following the issuance of the proposed regs, the preamble to the final regulations confirms that funds available for hardship distributions may include employer contributions that are made under a “safe harbor” 401(k) plan.

COMMENT:  Plans always have the option to limit the types of contributions (and earnings on such contributions) that are available for hardship distribution purposes. Therefore, for example, a plan may provide that employees may not receive a hardship distribution taken from employer contributions made under a safe-harbor plan, or from other specified types of contributions made under the plan.

Suspension of Contributions.

The final regulations include a list of the types of qualified retirement plans and other arrangements that cannot permissibly suspend contributions due to a hardship distribution. Further, the final regs clarify that if matching employee contributions are distributed in conjunction with a hardship distribution of elective deferrals, then suspension of employee contributions is not legally permissible.

Representation of Necessity to Meet Financial Need.

The final regulations create a single standard for determining whether a 401(k) plan participant has adequately represented that a distribution is necessary to satisfy a financial need. Specifically, a participant must represent that he or she has insufficient cash or other liquid assets “reasonably available” to satisfy the financial need. The final regulations also clarify that the plan administrator may accept a participant’s representation of financial need that is made over the telephone.

COMMENT: It would appear that this standard is widely open to interpretation. However, some assistance is offered: the preamble states, for example, that an employee could make a representation that he or she has insufficient cash or other liquid assets reasonably available to satisfy a financial need, even if the employee does in fact have cash or other liquid assets on hand, but those assets are earmarked for payment of an obligation in the near future (for example, rent). In such a case, therefore, the plan administrator could rely on the participant’s representation that the participant has insufficient cash or other liquid assets reasonably available to satisfy the financial need.

Effective Date.

The final regulations generally apply to distributions made on or after January 1, 2020. However, plan sponsors may choose to apply the final regs to hardship distributions that occur in plan years beginning after 2018 — and suspensions of contributions may be eliminated from the operation of the plan as of the first day of the first plan year beginning after 2018 — even if the hardship distribution occurred prior to that date.

Plan Amendments.

The deadline for amending a 401(k) plan to reflect changes in qualification requirements is the end of the second calendar year that begins after the IRS issues the Required Amendments List (“RAL” – see Section 9 of Rev. Proc. 2016–37) that includes the mandatory change. For example, if the mandatory change is included in the RAL issued for 2019, then the deadline for amending the plan to reflect the change would be December 31, 2021.

It will be necessary to review the 2019 RAL when it is issued later this year to determine whether changes to reflect the final hardship distribution regulations are included on the list. We will review the 2019 RAL when it is issued and release an update at such time.

The information and content contained in this blog post are for general informational purposes only, and does not, and is not intended to, constitute legal advice. As always, for specific questions regarding hardship distributions or other issues concerning your 401(k) retirement plan, please consult your own ERISA attorney or advisor.