IRS Final Rule Eases 401(k) Hardship Withdrawals
Making hardship withdrawals from 401(k) and 403(b) retirement plans soon will be easier for plan participants, and so will starting to save again following a hardship withdrawal.
On September 23, 2019 the IRS published in the Federal Register a final rule that relaxes several existing restrictions on taking hardship distributions from defined contribution plans. Some of these changes are mandatory, requiring employers to make
the changes by January 1, 2020, while others are optional.
Unlike loans, hardship withdrawals are not repaid to the plan with interest, so they permanently reduce the employee’s account balance. Hardship withdrawals also are subject to income tax. Also, if participants are younger than age 59½, they
are susceptible to an additional 10% early withdrawal tax penalty. For these reasons, withdrawals should be the last option for employees facing financial hardship.
The final rules implement the following key changes:
- Eliminate the 6-month contribution suspension requirement.
Starting January 1, 2020, plans will no longer be able to suspend employee contributions following a hardship distribution. Allowing participants to continue their contributions to the plan, and receive the employer match, helps them rebuild their savings
sooner. This change is mandatory.
- Eliminate the need to take a plan loan before a hardship withdrawal.
The new rule removes the requirement that participants take a plan loan first, if available, before making a hardship withdrawal. This change is optional.
- Make earnings available for withdrawal.
Effective in 2020, earnings on 401(k) contributions can be distributed for hardships, as can profit-sharing and stock-bonus contributions. Previously, employees could only withdraw contributions, not earnings. This change is mandatory. However, a plan
may limit the type of contributions available for hardship distributions and may exclude earnings on those contributions from hardship distribution eligibility.
Earnings on 403(b) contributions will remain ineligible for hardship withdrawals
because of a statutory prohibition that Congress did not amend.
- Eliminate need to provide documentation of hardship need.
Under the rules currently in place, plan administrators must take into account “all relevant facts and circumstances” to determine if a hardship withdrawal is necessary. The new rule only requires that a distribution not exceed what an employee
needs and that employees certify that they lack enough cash to meet their financial needs. Plan administrators can rely on that certification unless they have knowledge to the contrary. This change is mandatory.
To take a hardship withdrawal, employees currently must show an immediate and heavy financial need that involves one or more of the following:
- Purchase of a primary residence.
- Expenses to repair damage or to make improvements to a primary
residence that would qualify for a casualty deduction.
- Preventing eviction or foreclosure from a primary residence.
- Post-secondary education expenses for the upcoming 12 months for participants, spouses and children.
- Funeral expenses.
- Medical expenses not covered by insurance.
Among other changes, the final rule adds a seventh safe harbor category for expenses resulting from a federally declared disaster in an area designated by the Federal Emergency Management Agency (FEMA). This change is mandatory.
- Plan Amendments Are Required
The new laws take affect January 1, 2020. All plan documents must be amended to incorporate the law change. The deadline for amending individually designed plans is the end of their 2021calendar year. The deadline for prototype plan documents is the filing
date of the company’s 2020 tax return (including extensions).
The regulations note that the amendment deadline for 403(b) plans is March 30, 2020.
However, the Treasury and IRS are considering extending that deadline for the adoption ofamendments to conform to the final hardship regulations.
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