By Pension and Benefits Editorial Staff
The IRS is proposing to amend regulations on hardship distributions from 401(k) plans to reflect changes in the law. In particular, the proposed regulations would 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 is also proposing changes to reflect legislation concerning distributions for individuals serving in the armed services.
IRS Reg. Sec. 1.401(k)-1(d)(3) provides rules for determining whether a distribution is made on account of an employee’s hardship. Under those rules, a distribution is made on account of hardship only if the distribution is made on account of an immediate and heavy financial need and the amount of the distribution is not in excess of the amount necessary to satisfy that need (plus any amounts necessary to pay any taxes or penalties reasonably anticipated to result from the distribution).
For simpler administration, the regulations provide certain safe harbors that may be used to determine whether a distribution is made on account of an employee’s hardship. Specifically, IRS Reg. Sec. 1.401(k)-1(d)(3)(iii)(B) provides a safe harbor under which distributions for six types of expenses are deemed to be made on account of an immediate and heavy financial need. One of the six types is “expenses for the repair of damage to the employee’s principal residence that would qualify for the casualty deduction under section 165 (determined without regard to whether the loss exceeds 10% of adjusted gross income).”
In addition, IRS Reg. Sec. 1.401(k)-1(d)(3)(iv)(E) provides a safe harbor under which a distribution is deemed necessary to satisfy an immediate and heavy financial need. Under that safe harbor, an employee must first obtain all currently available distributions, and nontaxable plan loans from the plan and any other plan maintained by the employer. Also, an employee’s ability to make elective contributions and employee contributions to the plan (and any other plan maintained by the employer) must be suspended for at least six months after receipt of the hardship distribution.
Deemed immediate and heavy financial need safe harbor
Primary beneficiary. The proposed regulations modify the 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. PPA modified the hardship distribution rules to permit a 401(k) plan to treat a participant’s beneficiary under the plan the same as a participant’s spouse or dependent in determining whether the participant has incurred a hardship.
Residential casualty losses. The proposed regulations clarify the meaning of “casualty loss” to a principal residence for purposes of a hardship withdrawal is unaffected by the new Code Sec. 165(h)(5) limit. The Tax Cut Act added that provision to limit the deduction to personal casualty losses attributable to a federally declared disaster area for years 2018 through 2025, but the proposed regulations separate the limit from the hardship withdrawal rules.
Disaster area expenses. The proposed regulations would add a new expense category for damage incurred in federally declared disaster areas. The new safe harbor expense would be similar to relief given by the IRS after Hurricane Maria and the California wildfires in Announcement 2017-15. The change is intended to eliminate any delay or uncertainty concerning access to plan funds following a disaster that occurs in an area designated by the Federal Emergency Management Agency for individual assistance.
Distribution necessary to satisfy financial need. The proposed regulations reflect the changes directed by the Bipartisan Budget Act by modifying the rules for determining whether a distribution is necessary to satisfy an immediate and heavy financial need by eliminating the six-month prohibition on elective and employee contributions following a hardship distribution, and any requirement to take nontaxable plan loans prior to obtaining a hardship distribution.
In addition, the proposed 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 plan administrator may rely on such a representation unless the plan administrator has actual knowledge to the contrary.
The proposed regulations clarify 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, 2018) or, for distributions made before January 1, 2020, the representation described in the preceding paragraph, to demonstrate that a distribution is necessary to satisfy an immediate and heavy financial need of an employee.
Amount available for hardship withdrawal. Under IRS Reg. Sec. 1.401(k)-1(d)(3)(ii), the maximum amount that may be distributed on account of hardship is the total of the employee’s elective contributions that have not previously been distributed (plus earnings, qualified nonelective contributions (QNECs), and qualified matching contributions (QMACs) credited before a specified grandfather date that generally is before 1989). Pursuant to the Bipartisan Budget Act, the proposed regulations modify Reg. Sec. 1.401(k)-1(d)(3) to increase in the maximum amount available for hardship distribution by permitting distributions from 401(k) plans of elective contributions, QNECs, QMACs, and earnings on these contributions, regardless of when contributed or earned. However, plans may limit the type of contributions available for hardship distributions and whether earnings on those contributions are included.
403(b) plans. IRS Reg. Sec. 1.403(b)-6(d)(2) provides that a hardship distribution of 403(b) plan elective deferrals is subject to the rules and restrictions set forth in Reg. Sec. 1.401(k)-1(d)(3). Thus, the proposed new rules relating to a hardship distribution of elective contributions from a 401(k) plan generally apply to 403(b) plans. However, Code Sec. 403(b)(11) was not amended by Section 41114 of Bipartisan Budget Act. Therefore, income attributable to 403(b) plan elective deferrals continues to be ineligible for distribution on account of hardship. In addition, QNECs and QMACs in a 403(b) plan that are not in a custodial account may be distributed on account of hardship, but QNECs and QMACs in a 403(b) plan that are in a custodial account continue to be ineligible for distribution on account of hardship.
Applicability dates and reliance. The changes to the hardship distribution rules generally would apply to distributions made in plan years beginning after December 31, 2018. However, 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. 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.
SOURCE: 83 FR 56763.
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