Final Regulations Amend Hardship Distribution Rules from Section 401(k) Plans
The IRS has issued final regulations that amend the rules relating to hardship distributions from Code Sec. 401(k) plans. The final regulations are substantially similar to the proposed regulations. Further, plans that complied with the proposed regulations satisfy the final regulations as well. The regulations are effective on September 23, 2019.
The final regulations:
- reflect statutory changes affecting Code Sec. 401(k) plans, including changes made by the Bipartisan Budget Act of 2018 ( P.L. 115-123); and
- affect participants in, beneficiaries of, employers maintaining, and administrators of plans that include cash or deferred arrangements or provide for employee or matching contributions.
Deemed Immediate and Heavy Financial Need
The final 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. The final regulations:
- add “primary beneficiary under the plan” as an individual for whom qualifying medical, educational, and funeral expenses may be incurred;
- modify the expense listed in existing Reg. §1.401(k)-1(d)(3)(iii)(B)(6) to provide that the limitations in Code Sec. 165(h)(5) do not apply for this purpose; and
- add to the list a new type of expense, relating to expenses incurred as a result of certain disasters.
Distribution Necessary to Satisfy Financial Need
The final regulations modify the rules for determining whether a distribution is necessary to satisfy an immediate and heavy financial need, by:
- eliminating any requirement that an employee be prohibited from making elective contributions and employee contributions after receipt of a hardship distribution; and
- eliminating any requirement to take plan loans prior to obtaining a hardship distribution.
In particular, the final regulations, like the proposed regulations, eliminate the safe harbor in existing Reg. §1.401(k)-1(d)(3)(iv)(E), under which a distribution is deemed necessary to satisfy the financial need only if elective contributions and employee contributions are suspended for at least six months after a hardship distribution is made and, if available, nontaxable plan loans are taken before the hardship distribution is made.
Expanded Sources for Hardship Distributions
The final regulations modify existing Reg. §1.401(k)-1(d)(3) to permit hardship distributions from Code Sec. 401(k) plans of elective contributions, qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and earnings on these amounts, regardless of when contributed or earned.
Section 403(b) Plans
A hardship distribution of Code Sec. 403(b) elective deferrals is subject to the rules and restrictions set forth in Reg. §1.401(k)-1(d)(3). Accordingly, the preamble to the proposed regulations had stated that the new rules relating to a hardship distribution of elective contributions from a Code Sec. 401(k) plan generally apply to Code Sec. 403(b) plans. Because this requirement is retained in the final regulations, at Reg. §1.401(k)-1(d)(3)(iii)(B), it applies to Code Sec. 403(b) plans.
The changes to the hardship distribution rules made by the Bipartisan Budget Act of 2018 are effective for plan years beginning after December 31, 2018.
The Treasury Department and IRS expect that plan sponsors will need to amend their plans’ hardship distribution provisions to reflect the final regulations, and any such amendment must be effective for distributions beginning no later than January 1, 2020. The deadline for amending a disqualifying provision is set forth in Rev. Proc. 2016-37, I.R.B. 2016-29,136.