By Janice Fortin, CPA, MST – Shareholder, Doeren Mayhew

Recently, the Internal Revenue Service (IRS) issued final regulations on 401(k) hardship withdrawals, relaxing current restrictions and easing the process for plan participants. Set to go into effect Jan. 1, 2020, some of the changes stemming from the regulation are mandatory, while others are voluntary. Plan documents will need to be amended to include the new provisions. Required amendment dates will vary by type of plan and document, and whether the plan sponsor elected to early-implement any changes prior to the required Jan. 1, 2020 date.

Changes to Note

Outlined below are key provisions to note from the new regulation:

Elimination of contribution-suspension requirements.

Under the Bipartisan Budget Act, plan administrators were required to suspend a participant’s contributions for a six-month period when taking a hardship withdrawal. Under the final rule, plans will no longer be able to prevent participants from making contributions following a hardship withdrawal, effective Jan. 1, 2020. Plan sponsors have the option to implement this change as soon as Jan. 1, 2019. The new rule applies to 401(k), 403(b) and governmental 457(b) plans, but its optional for tax-exempt 457(b) plans.

Lifted plan loan requirement before hardship withdrawal.

Participants are no longer required to first take a plan loan before making a hardship withdrawal. Instead, plan sponsors are given the discretion on whether they will require taking a plan loan before being eligible for a hardship withdrawal. Once implemented, this provision would apply to all participants equally.

Earnings on 401(k) plan accounts eligible for hardship withdrawal.

Under prior regulations, participants were only allowed to withdraw contributions (deferrals, ordinary matching and ordinary nonelective employer contributions), while all earnings and other contribution sources were to remain untouched. The new rule allows plan earnings, as well as all other types of elective and nonelective contributions plus earnings thereon, to be available for hardship withdrawal distribution on or after the Jan. 1, 2020 effective date. Note, earnings on 403(b) plan deferrals continue to be excluded from hardship distribution.

Hardship verification relaxed.

Today, plan sponsors are required to review a participant’s situation and financial condition to verify the need for a hardship withdrawal. This changes under the new rule. Effective for hardship distributions after Dec.31, 2019, plan sponsors will only need to confirm the distribution is the minimum amount necessary to meet the participant’s financial needs (grossed up for taxes) and that there is no reason to believe otherwise the employee has the financial need.

Participants taking a hardship withdrawal will be required to submit a “signed” statement to certify their need for the funds and a lack of funds or assets otherwise available. Participants may submit their verification in writing, through email or electronic portal, or via a recorded phone call. Plan sponsors can rely on the participant’s certification of financial need for processing the hardship withdrawal and will no longer need to seek additional information about the employee’s financial condition, so long as there is no known information suspecting that the employee is not in need.

Expansion and clarification of safe-harbor rules.

Under the current ‘safe-harbor hardship’ rules, withdrawals were available to participants with a large and urgent financial need due to any of the following: purchasing a primary residence, payments to prevent eviction or foreclosure on a primary residence, costs involved for repairs to a primary residence for damage due to a casualty loss, post-secondary education expenses for participants, spouses and children for the forthcoming 12-month period, funeral expenses and medical expenses that insurance does not cover.

The new safe harbor rules will add categories covering expenses and losses (including lost wages, temporary rent and loss of personal property, as well as the cost of damage to the principal residence) incurred from a FEMA-declared disaster for those employees who either live or work within the declared disaster area. The IRS will no longer indicate which disaster areas it considers to be covered for hardship rules; rather, all FEMA-declared disaster areas will qualify.

Additionally, the new law clarifies that for other casualty losses that are not due to a FEMA-declared disaster, they may still be covered under the hardship rules. However, the plan document must be amended to allow for non-FEMA casualty losses and covered casualty losses to only include those specifically related to the participant’s primary residence.

The new law also clarifies a primary beneficiary’s medical, educational and funeral expenses are included within the deemed hardship rules.

Implementing Amendments and Amending Plan Documents

If your 401(k) plan permits hardship distributions, operational changes will need to be updated to comply with the new regulations by the effective Jan. 1, 2020 date. Many changes, such as the expansion of sources of hardship distributions, can be operationally effective as early as the first day of the 2019 plan year.

There are various required plan document amendment deadlines, depending on the type of plan, documentation currently utilized and when the plan sponsor put changes into operation:

For 401(k) plans using a pre-approved document (a prototype or volume submitter): The amendment must be adopted by the tax filing deadline, including extensions, of the plan sponsor’s return for the tax year which includes Jan.1, 2020.  This is true even if changes were adopted into practice in 2019.

  • For individually designed plan documents (attorney drafted): The amendments must be in place by Dec. 31, 2021. If your plan doesn’t follow a calendar year, your implementation date may vary.
  • For 403(b) plans: The deadline for amendment is the last day of the calendar year after the calendar year in which the change was operationally put into effect. Thus, for a calendar year 403(b) plan that operationally puts hardship changes into place in 2019, they will have until Dec.31, 2020 to adopt the amendments.

Should you need assistance interpreting how these rules specifically impact your plan or executing the changes, contact one of our employee benefit plan specialists.