Tax reform bill increases scope of hardship withdrawal options
While preserving 401(k) retirement plan’s tax-deferral status, the U.S. House of Representatives’ tax reform bill introduced last week did make some minor changes to hardship withdrawals that affect how plan advisers should approach their retirement plans. By allowing participants to continue contributions after a hardship withdrawal, include employer contributions in the amount they can withdraw and permitting hardship withdrawals instead of loans, the bill both increases the scope of options a participant has in the event of hardship while also making it more palatable.
These changes could result in more plan leakage by allowing larger sums to be withdrawn, including employer contributions, and removing the six-month contribution penalty.
Advisers should be proactive in educating plan sponsors and participants through a holistic financial wellness program to help prevent these sorts of withdrawals.
Obviously, hardships are available to participants as a safety measure due to unforeseen circumstances. Financial wellness and education programs need to be proactive to set participants up for success and the ability to not only have a healthy retirement, but to also be able to financially weather unexpected life events.
Advisers should think big and small when considering their programs. This first comes from a deep understanding of the plan, its participants and its sponsor. While advisers should clearly understand the provisions of the plan and be able to explain it to participants, they should also have a finger on the pulse of what is most troublesome or of interest to participants.
Consider conducting surveys, holding focus groups, or cataloguing the one-on-one conversations had with participants. Topic areas to research can include: Do participants have suitable liquid savings to handle unexpected financial stress? Are debt levels and service maintainable? What else keeps participants up at night?
The big picture
From these findings, develop a financial wellness plan to answer participant concerns. If liquid assets are inadequate, educate on how disruptive a financial strain can be. If debt levels are preventing participants from saving, teach about debt reduction strategies and cash flow management.
Sponsors will need to provide buy in. They must be willing to allow for employee time to be used to formulate the findings necessary for an effective financial wellness plan. Then they should allow for the education program to be implemented. This means seeing the big picture and understanding that financially healthy participants can be more productive and may retire on time, enabling a workforce to become younger and less expensive via compensation and benefits costs.
Let’s face it, the proposed changes could be considered a compassionate outcome. However, they don’t address the problems that often lead to hardship withdrawals in the first place. If we want fiscally healthy participants who are on track for retirement, we can’t rely on a tax reform bill—participants must help themselves. Advisers and sponsors can empower and educate participants to bridge the gap. If not, it could result in greater plan leakage and larger hardship withdrawals. On the bright side, at least the IRS would receive more tax and penalty revenue. Need to fund those deficits somehow.
This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does adviser assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
Securities and Advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.