Guiding employees before they take hardship distributions from 401(k) plans
Earlier this year, Congress passed, and the President signed into law, H.R. 1892, the Bipartisan Budget Act of 2018. In addition to providing a continuing resolution to fund the federal government, the Act includes a change affecting hardship distributions from 401(k) plans.
Under the new law, 401(k) plans may provide that an employee can receive a distribution of elective contributions (including earnings) from the plan on account of a hardship during employment. This is an exception to the general rule that limits any in-service distributions of elective contributions to those employees who have reached age 59.5 and then only if the plan so provides.
Generally, a plan may make a hardship distribution only under the following conditions:
· the plan expressly permits hardship distributions
· distributions are made because of an “immediate and heavy” financial need of the employee
· distributions are made only in an amount necessary to meet that financial need.
Under the 401(k) regulations, an employee who receives a hardship distribution cannot make elective contributions or other employee contributions (pre-tax, after-tax, or Roth) to the plan (or any other plan maintained by the employer) for at least six months after receipt of the hardship distribution. Employees are also generally required to take available plan loans before they are eligible to receive a hardship distribution.
Hardship distributions under the Act
The Act directs the Internal Revenue Service to modify the 401(k) regulations, within one year from February 9, 2018, to remove the six-month prohibition on contributions following receipt of a hardship distribution and to make “any other modifications necessary to carry out the purposes of” the Internal Revenue Code applicable to hardship distributions from 401(k) plans. The revised regulations will apply to plan years beginning after December 31, 2018.
In addition, the Act provides special rules regarding hardship withdrawals under the Code. Under the Code provision, as revised, the following amounts may be distributed upon hardship of the employee:
· contributions to a profit-sharing (including a 401(k) plan) or stock bonus plan that has a cash-or-deferred arrangement
· qualified non-elective contributions (vested employer contributions such as those made to a safe harbor plan)
· qualified matching contributions (vested employer matching contributions such those made to a safe harbor plan)
· earnings on the foregoing contributions.
As a result, the Act broadens the sources of hardship distributions to include qualified non-elective contributions and qualified matching contributions (and earnings on such contributions). Also, a distribution will not be treated as failing to be made upon the hardship of an employee solely because the employee does not take any available plan loan. These changes also apply to plan years beginning after December 31, 2018.
Employers are not required to amend their plans to remove the current six-month prohibition on contributions after an employee takes a hardship distribution. However, the six-month prohibition is part of the regulatory safe harbor requirements for hardship distributions, which will be revised in accordance with the Act. Therefore, employers who use the safe harbor will likely need to amend their plans to retain the benefit of the safe harbor. Employers do not appear to be required to permit the additional sources for hardship distributions or to remove the requirement that plans loans be taken before receiving a hardship distribution.
Further IRS guidance on these issues — as well as the application of the changes to 403(b) plans —would be helpful. These changes could simplify plan administration and are likely to be welcomed by participants, so it seems likely that most employers would want to make them.