On September 19, 2019, the IRS issued final regulations updating the rules for hardship withdrawals from 401(k) plans. These regulations primarily reflect changes made by the Tax Cuts and Jobs Act and the Bipartisan Budget Act of 2018 and are very similar to the regulations that the IRS proposed late last year.
Final Regulations. The final regulations provide, in pertinent part, as follows:
- Elimination of 6-Month Suspension. Beginning January 1, 2020, plans may no longer impose a 6-month suspension on participants who take hardship withdrawals.
- In lieu of the 6-month suspension, effective as of January 1, 2020, plans must require participants to sign (or electronically execute) a statement certifying that they have no other cash or liquid assets reasonably available from which they can satisfy the hardship. The plan administrator may rely on this certification unless it knows it to be inaccurate.
- Although elimination of the 6-month suspension is not required until January 1, 2020, plan sponsors could choose to eliminate it as early as January 1, 2019. Suspensions may be eliminated during 2019 without participant certifications.
- Plan sponsors are also free to lift any hardship suspensions that were previously in place.
- Requirement to Take Loans Before Hardship Withdrawals Permitted But Not Required. The regulations provide that a plan may require a participant to take all available loans before a hardship withdrawal, but it is no longer mandatory.
- As is the case under the current regulations, the participant still must have taken all other withdrawals and distributions currently available from all other qualified and nonqualified plans.
- The final regulations continue to require that participants withdraw any available ESOP dividends before taking a hardship withdrawal, but the IRS notes that only “currently available” ESOP dividends must be withdrawn. In the preamble to the regulations, IRS states that an ESOP dividend is “currently available” if, at the time the participant submits a hardship withdrawal request, the dividend both (i) has been paid to the plan, and (ii) is available for the employee to elect in cash. Therefore, if a plan requires a participant to make an election to receive ESOP dividends before the dividend payment date, these dividends will not be currently available.
- Amounts Eligible for Withdrawal. Plans may allow hardship withdrawals of all earnings on elective contributions. Previously, only earnings on elective contributions accrued before 1989 were eligible for hardship withdrawal. Plans may also allow hardship withdrawals from safe harbor contributions and qualified nonelective contributions (“QNECs”) and qualified matching contributions (“QMACs”).
- Hardship Withdrawals Related to Damage to Principal Residence. The Tax Cuts and Jobs Act restricted the casualty loss deduction to losses attributable to a federally declared disaster. With respect to withdrawals made on or after January 1, 2018, the regulations clarify that, for purposes of hardship withdrawals related to damage to a principal residence that would qualify for a casualty loss deduction, the restriction that the loss be attributable to a federally declared disaster does not apply.
- Expansion of Safe-Harbor Hardship Expenses. The 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 similar to the IRS’s past administrative practice of granting relief from hardship standards following natural disasters such as hurricanes and wildfires. Note, however, the regulations are limited to expenses and losses of the participant, not the participant’s relatives or dependents, and the regulations do not include the relaxed hardship documentation requirements that have typically accompanied the IRS’s federally declared disaster relief. Nevertheless, the preamble states that plan administrators can exercise some flexibility with respect to the documentation requirements following a natural disaster.
Timing and Form of Changes. Most of the changes made by the regulations are optional. However, plans are required to operationally eliminate the 6-month suspension and begin requiring the new participant certification no later than January 1, 2020. This deadline applies even if the plan year does not coincide with the calendar year.
Plan Amendment Deadline. Although operational changes are required sooner, individually designed plans are not required to be amended for the final regulations until December 31, 2021. A later deadline may apply if the plan is not a calendar year plan or if the IRS delays the inclusion of these regulations in its annual Required Amendment List.
Sponsors that have adopted pre-approved plans may have a slightly earlier amendment deadline, but it will be no earlier than the latest date for the sponsor to file its corporate tax return for its 2020 tax year.
Next Steps. Many recordkeepers have already begun the process of implementing changes based on the statutory provisions and the proposed regulations and are soliciting decisions from their client plan sponsors.
We expect that most sponsors will choose to eliminate the loan and suspension requirements and to allow the expanded distributions of earnings on elective contributions. However, 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.
If you have questions about the changes to the hardship withdrawal rules, please contact your Executive Compensation and Employee Benefits Counsel at Smith, Gambrell & Russell, LLP.