With the impetus of the Bipartisan Budget Act of 2018, the IRS has provided for comment some much-anticipated new proposed regulations on hardship distributions.
Generally speaking, the changes will make it easier for participants to get, and to get more, when requesting a hardship distribution – and many of the “penalties” associated with taking a hardship distribution (imposed to help assure that the circumstances were truly a hardship, though some might argue they simply exacerbated the situation) are removed. Moreover, the criteria for hardship has also been expanded.
Hardship Definition Expanded
Specifically, the proposed 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 (regulations had previously referenced only a spouse or dependent);
- clarifying that the home casualty reason for hardship does not have to be in a federally declared disaster area (an unintended consequence of the Tax Cuts and Jobs Act of 2017); and
- adding a new type of qualifying expense to the list – expenses incurred as a result of certain disasters that the IRS and Congress have traditionally, but separately, provided relief for in the past, such as hurricanes, floods, wildfires, etc. This, the IRS explains, 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 (FEMA) for individual assistance.”
These updated list of safe harbor expenses may be “applied to distributions made on or after a date that is as early as January 1, 2018.” The proposed regulation notes that this retroactive date was meant to protect those that may not have understood the “165h” issue caused by TCJA noted above.
The account balances that may be accessed for hardship have been expanded to include:
Elective deferrals plus earnings
QNECs, QMACS, safe harbor contributions, QACA – all of these plus earnings, “regardless of when contributed or earned”
Note that individual plans may decide to limit the sources for hardship availability.
The proposed regulations “eliminate the safe harbor…under which a distribution is deemed necessary to satisfy the financial need only if elective contributions and employee contributions are suspended for at least 6 months after a hardship distribution is made and, if available, nontaxable plan loans are taken.” However, the IRS, acknowledging the “timing of the publication of these proposed regulations,” says that the prohibition on suspending contributions “would only apply for a distribution that is made on or after January 1, 2020.”
The regulations also eliminate the rules under which the determination of whether a distribution is necessary to satisfy a financial need is based on all the relevant facts and circumstances, replacing it with a general standard for determining whether a distribution is necessary. That general standard is that:
- The hardship may not exceed amount of need, adjusted for anticipated taxes and penalties.
- The participant must have obtained all other available distributions under the employer’s plans (other than loans, as had been the case under the current regulations).
- The participant must represent that he or she has insufficient cash or liquid assets to satisfy that financial need.
- The plan administrator may rely on this representation, barring “actual knowledge” to the contrary.
The IRS notes that, in light of the timing of the publication of the regulation, “the requirement to obtain this representation would only apply for a distribution that is made on or after January 1, 2020.” That said, the regulations note that plan generally may provide for additional conditions for distributions made before January 1, 2020, “…to demonstrate that a distribution is necessary to satisfy an immediate and heavy financial need of an employee.”
As for 403(b) plans, the IRS notes that since 403(b)(11) was not amended by the BBA 2018, “income attributable to section 403(b) elective deferrals continues to be ineligible for distribution on account of hardship,” that QNECs and QMACs in a Section 403(b) plan that are not in a custodial account may be distributed on account of hardship, but that “QNECs and QMACs in a Section 403(b) plan that are in a custodial account continue to be ineligible for distribution on account of hardship.”
Expanding Current Hurricane Relief
Recognizing that “employees adversely affected by Hurricane Florence or Hurricane Michael may need expedited access to plan funds,” the IRS extended the relief provided under Announcement 2017-15 “to similarly situated victims of Hurricanes Florence and Michael,” but extended that relief through March 15, 2019, noting that any necessary amendments must be made no later than the deadline for plan amendments “set forth in this preamble under Plan Amendments.”
The changes to the hardship distribution rules made by BBA 2018 are effective for plan years beginning after Dec. 31, 2018, and the proposed regulations provide that they generally would apply to distributions made in plan years beginning after Dec. 31, 2018. However, the IRS notes that 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 Dec. 31, 2018, “even if the distribution was made in the prior plan year,” therefore a person under elective deferral suspension in the second half of the 2018 plan year may resume (if the plan allows) deferring as of the first day of the 2019 plan year.
The IRS also notes that the revised list of safe harbor expenses may be applied to distributions made on or after a date that is as early as Jan. 1, 2018. Moreover, it notes that a plan may be amended to apply the revised safe harbor expense relating to losses (including loss of income) incurred by an employee on account of a disaster that occurs in 2018 (such as Hurricane Florence or Hurricane Michael), “provided that the employee’s principal residence or principal place of employment at the time of the disaster was located in an area designated by FEMA for individual assistance with respect to the disaster.”
Assuming these proposed regulations become law, plan sponsors will need to amend their plans’ hardship distribution provisions – by the end of second year after the issuance of the Required Amendments list. What’s less clear at this point (but might be cleared up via the comment period/process) is the timing and manner of changes to changes to preapproved plans – it may even be that these changes can be incorporated in the third cycle restatements that are due to the IRS by Dec. 31.