The IRS has issued final regulations that amend the rules relating to hardship distributions from Code Sec. 401(k) plans. The final regulations are substantially similar to the proposed regulations. Plans that complied with the proposed regulations satisfy the final regulations as well, according to the IRS. The regulations are effective on September 23, 2019.
The final regulations reflect changes in the Bipartisan Budget Act of 2018 (P.L. 115-123), the Tax Cuts and Jobs Act (P.L. 115-97), and the Pension Protection Act of 2006 (P.L. 109-280). The IRS has also finalized changes to reflect legislation concerning distributions for individuals serving in the armed services.
Deemed immediate and heavy financial need. The final 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 “primary beneficiary under the plan” as an individual for whom qualifying medical, educational, and funeral expenses may be incurred;
- modifying the expense listed in existing IRS Reg. §1.401(k)-1(d)(3)(ii)(B)(6) (relating to damage to a principal residence that would qualify for a casualty deduction under Code Sec. 165) to provide that for this purpose the deduction limitations in Code Sec. 165(h)(5) do not apply; and
- adding a new type of expense to the list, relating to expenses in connection with damage incurred in federally declared disaster areas.
Several commenters observed that this new safe harbor expense is narrower in certain respects than IRS disaster relief announcements and asked for confirmation that the narrowing is intentional. Some commenters also raised the concern that the new safe harbor expense would lead the IRS to discontinue its practice of issuing announcements providing disaster relief.
The IRS explains that the new safe harbor expense differs from the disaster relief announcements in three main ways. First, only disaster-related expenses and losses of an employee who lived or worked in the disaster area will qualify for the new safe harbor expense, and not, as under the disaster-relief announcements, expenses and losses of the employee’s relatives and dependents. Second, unlike under the disaster relief announcements, there is no specific deadline by which a request for a disaster-related hardship distribution must be made and no specific authority to relax certain procedural requirements established by the plan administrator or plan terms. The IRS expects that plan administrators will be flexible in interpreting plan terms requiring documentation relating to a hardship following a disaster. Third, unlike under the disaster relief announcements, there is no extended deadline for plan sponsors to add disaster-related distribution or loan provisions to the plan. In the absence of an extended deadline, a plan sponsor that does not choose to add disaster-related hardship distribution provisions as part of an amendment reflecting the final regulations, but instead chooses to wait until a disaster occurs to add those provisions (or to add a loan provision), would need to adopt a plan amendment by the end of the plan year the amendment is first effective.
The IRS states that making expenses related to certain disasters a safe harbor expense is intended to eliminate any delay or uncertainty concerning access to plan funds that might otherwise occur following a major disaster. Therefore, the IRS expects that no more disaster relief announcements will be needed. However, the IRS is considering separate guidance to address delayed amendment deadlines when the new safe harbor expense or loan provisions are added to a plan at a later date in response to a particular disaster.
Distribution necessary to satisfy financial need. The final regulations modify the rules for determining whether a distribution is necessary to satisfy an immediate and heavy financial need by eliminating:
- any requirement that an employee be prohibited from making elective contributions and employee contributions after receipt of a hardship distribution;
- any requirement to take plan loans prior to obtaining a hardship distribution.
Thus, the final regulations, like the proposed regulations, eliminate the safe harbor in existing IRS Reg. §1.401(k)-1(d)(3)(iv)(E), under which a distribution is deemed necessary to satisfy the financial need only if elective contributions and employee contributions are suspended for at least six months after a hardship distribution is made, and, if available, nontaxable plan loans are taken before the hardship distribution is made.
Like the proposed regulations, the final regulations eliminate the rules in current IRS Reg. Sec. 1.401(k)-1(d)(3)(iv)(B) (under which the determination of whether a distribution is necessary to satisfy a financial need is based on all the relevant facts and circumstances) and provide one general standard for determining whether a distribution is necessary. Under this general standard, a hardship distribution may not exceed the amount of an employee’s need (including any amounts necessary to pay any federal, state, or local income taxes or penalties reasonably anticipated to result from the distribution), the employee must have obtained other available distributions under the employer’s plans, and the employee must represent that he or she has insufficient cash or other liquid assets to satisfy the financial need. A hardship distribution may not be made if the plan administrator has actual knowledge that is contrary to the representation. However, the final regulations contain modifications in response to comments received.
One commenter was concerned that the requirement for an employee to make a representation regarding the unavailability of cash or other liquid assets to satisfy the financial need would be a problem if the employee has assets but has another immediate need for them. In response, the final regulations provide that the employee representation only relates to whether the employee has cash or other liquid assets that are “reasonably available” to satisfy the need. Thus, 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 did have cash or other liquid assets on hand, provided those assets were earmarked for payment of an obligation in the near future (for example, rent).
The final regulations, like the proposed regulations, provide that a plan generally may provide for additional conditions, such as those described in IRS Reg. Sec. 1.401(k)-1(d)(3)(iv)(B) and (C) (revised as of April 1, 2019), to show that a distribution is necessary to satisfy an immediate and heavy financial need of an employee. However, like the proposed regulations, the final regulations do not permit a plan to provide for a suspension of elective contributions or employee contributions as a condition of obtaining a hardship distribution. In response to a commenter’s question about other possible conditions that could be imposed on a hardship distribution, the IRS agreed that completing a plan’s application process and providing required documentation are permissible conditions. The IRS also notes that plan sponsors have available a broad range of conditions that may be imposed on a hardship distribution—for example, a plan could provide for a nondiscriminatory, minimum dollar amount for a hardship distribution.
Another commenter requested guidance on which other plans of the employer, besides the plan making the hardship distribution, are subject to the prohibition on suspensions. The proposed regulations did not specify the plans to which the prohibition on suspensions applied. The IRS has concluded that Congress’ concerns underlying Section 41113 of Bipartisan Budget Act of 2018 have little relevance to unfunded nonqualified plans. Accordingly, the final regulations provide that the prohibition on suspensions applies only to a qualified plan, a 403(b) plan, and an eligible deferred compensation plan described in Code Sec. 457(b) maintained by an eligible employer described in Code Sec. 457(e)(1)(A).
Expanded sources for hardship distributions. The final regulations modify existing IRS Reg. §1.401(k)-1(d)(3) to permit hardship distributions from Code Sec. 401(k) plans of elective contributions, QNECs, QMACs, and earnings on these amounts, regardless of when contributed or earned.
403(b) plans. A hardship distribution of Code Sec. 403(b) elective deferrals is subject to the rules and restrictions set forth in Reg. §1.401(k)-1(d)(3). Thus, under the final regulations, the new rules relating to a hardship distribution of elective contributions from a Code Sec. 401(k) plan generally apply to Code Sec. 403(b) plans.
Applicability dates. The changes to the hardship distribution rules made by the Bipartisan Budget Act of 2018 are effective for plan years beginning after December 31, 2018. The final regulations provide plan sponsors with a number of applicability date options. The IRS explains that, although presented differently in the proposed regulations, the options available to plan sponsors under the final regulations are the same as those available under the proposed regulations.
In response to a comment on the proposed regulations requesting clarity regarding which rules apply during 2019, the final regulations provide that Reg. §1.401(k)-1(d)(3) applies to distributions made on or after January 1, 2020 (rather than, as in the proposed regulations, to distributions made in plan years beginning after December 31, 2018). However, Reg. §1.401(k)-1(d)(3) may be applied to distributions made in plan years beginning after December 31, 2018, and the prohibition on suspending an employee’s elective contributions and employee contributions as a condition of obtaining a hardship distribution may be applied as of the first day of the first plan year beginning after December 31, 2018, even if the distribution was made in the prior plan year.
If Reg. §1.401(k)-1(d)(3) is applied to distributions made before January 1, 2020, the new rules requiring an employee representation and prohibiting a suspension of contributions may be disregarded with respect to those distributions. To the extent early application of Reg. §1.401(k)-1(d)(3) is not chosen, the rules in Reg. §1.401(k)-1(d)(3), prior to amendment by these final regulations, apply to distributions made before January 1, 2020, taking into account statutory changes effective before 2020 that are not reflected in that regulation. In addition, the revised list of safe harbor expenses may be applied to distributions made on or after a date that is as early as January 1, 2018.
Plan amendments. The IRS expects that plan sponsors will need to amend their plans’ hardship distribution provisions to reflect the final regulations, and any such amendment must be effective for distributions beginning no later than January 1, 2020. The deadline for amending a disqualifying provision is set forth in Rev. Proc. 2016-37. In addition, a plan provision that does not result in the failure of the plan to satisfy the qualification requirements, but is integrally related to a qualification requirement that has been changed in a manner that requires the plan to be amended, may be amended by the same deadline that applies to the required amendment.
The IRS has provided additional guidance on plan amendments, including amendment deadlines for pre-approved plans. The IRS is extending the deadline for an interim amendment related to the hardship distribution provisions. Under this extension, for an employer using a pre-approved plan, the interim amendment deadline for the required amendment to the hardship distribution provisions of the plan will also be the deadline for all amendments integrally related to the hardship distribution provisions (rather than the earlier deadline that might otherwise apply under Rev. Proc. 2016-37 to those integrally related amendments).
In response to commenters’ requests for guidance on amendment deadlines for pre-approved and individually designed 403(b) plans, the IRS states that it is considering providing a later amendment deadline in separate guidance.
SOURCE: 84 FR 49651.
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