The awaited final regulations for hardship distributions were released by the IRS in September 2019. The new regulations were a response to proposed changes to the Bipartisan Budget Act of 2018, the 2018 proposed regulations, the Tax Cuts and Jobs Act and other legislation. The regulations put in place proposed changes to hardship distribution rules for 401(k) plans and 403(b) plans.
When Congress passed the Bipartisan Budget Act of 2018 and the Tax Cuts and Jobs Act (collectively “The Acts”), it impacted two retirement plan features: participant hardship distributions and participant loans. We first put together this article in 2018—with the September 2019 legislation, these changes have been finalized.
Changes to Hardship Distributions
Certain life events may cause plan participants to request a hardship distribution.* The Acts have changed some aspects of this process:
- Participant loans are not required to be taken prior to a hardship distribution.
Regulations state that, if a plan document allows hardship distributions, the participant must have an immediate and heavy financial need. Prior to The Acts, the participant had to make use of all other currently available distributions, such as ESOP dividends under section 404(k) or other plan loans, prior to taking a hardship distribution.
This caused a problem for many participants because they were not financially able to make loan payments. The Acts alleviate this financial strain for participants by removing the requirement of a participant loan before taking a hardship distribution.
- Assets from participant deferrals, QNECs and QMACs, and their earnings can be used for hardship distributions.
Previous regulations stated that hardship distributions could be made from participant contributions, qualified nonelective contribution (QNEC), and qualified matching contribution (QMAC) accounts. But the earnings associated with these sources were not eligible to be used for a hardship distribution. The Acts now permit these earnings to be included in allowable distributable assets for hardship distributions. This increases the potential assets available for a participant to use.
- Participants do not have to suspend participant deferrals for six months following a hardship distribution.
Previous regulations stated that, following a hardship distribution, a participant cannot contribute elective deferrals into the plan for six months. The Acts removed this provision. Participants can now receive their hardship distribution and continue to contribute salary deferrals into the plan.
* (Details on a 2017 IRS memo and other hardship distribution regulations can be found here: https://www.cshco.com/articles/irs-crack-hardship-distributions-mean/.)
Changes to Participant Loans
Many defined contribution plans allow their participants to obtain a loan from their account balance as long as the loan is the lesser of 50% of their account balance or $50,000. (There are a few other factors when determining a maximum loan available, but they are not discussed in this article.)
Previously, when a participant terminated and had a loan balance in the plan, they had to either pay back the loan, offset their account balance by the loan balance (which is a taxable event), or contribute the loan balance to an IRA (rollover) within 60 days of termination. Many participants are unaware of the tax consequence of offsetting their loan if they do not pay it back or rollover the loan within 60 days.
The Acts have extended the 60-day window to the filing due date, including extensions, of the participant’s tax return. This will give terminated participants more time to handle their loan balance without causing a taxable event.
If you have questions about how these changes may affect your plan or participants, contact your CSH qualified plan advisor.