IRS Issues Proposed Regulations on Hardship Distribution Rules

Practical Law Legal Update w-017-5260 (Approx. 5 pages)

IRS Issues Proposed Regulations on Hardship Distribution Rules

by Practical Law Employee Benefits & Executive Compensation

Current Hardship Distribution Rules

Under the current regulations, a hardship distribution can be made to a plan participant if the distribution is:

Because of an immediate and heavy financial need. The Code requires the plan to set out objective and nondiscriminatory standards to determine the existence of an immediate and heavy financial need. Determining this need depends on the facts and circumstances as determined by the plan sponsor.
Limited to the amount necessary to satisfy that financial need.

Under a safe harbor (26 C.F.R. § 1.401(k)-1(d)(3)(iv)(E)) a participant is automatically considered to have an immediate and heavy financial need for certain specified expenses in the Code.

On February 9, 2018, the Bipartisan Budget Act of 2018 (Pub. L. No. 115-123) was signed into law. The Act includes provisions that, among other things, modify the hardship distribution rules.

Proposed Regulations

The proposed regulations would amend the regulations governing hardship distributions from 401(k) plans to reflect statutory changes, including provisions concerning:

The participant's immediate and heavy financial need.
Whether the distribution is necessary to satisfy the financial need.
The amounts includible in hardship distributions.

Immediate and Heavy Financial Need

The proposed regulations would amend the safe harbor under which a participant is deemed to have an immediate and heavy financial need if the hardship distribution is for certain specified expenses (26 C.F.R. § 1.401(k)-1(d)(3)(iii)(B); see Hardship Distribution Checklist: Safe Harbor (Immediate and Heavy Financial Need)). The proposed regulations would:

Reflect changes made by the PPA and add the participant's primary beneficiary as an individual for whom qualifying medical, tuition, and funeral expenses could be incurred.
Modify the provision concerning expenses that qualify for the casualty deduction under Code Section 165 to specify that the deduction limitation added by the TCJA does not apply (26 U.S.C. § 165(h)(5)).
Add expenses and losses incurred because of a federally declared disaster, provided the participant's principal residence or place of employment at the time of the disaster was located in the designated disaster area.

Distribution Necessary to Satisfy the Financial Need

The proposed regulations would:

Eliminate the regulatory safe harbor under which a distribution is deemed necessary to satisfy an immediate and heavy financial need if:
- the participant is prohibited from making contributions for a six-month period following the distribution; and
- the participant takes an available loan under the plan before taking a hardship withdrawal.
(26 C.F.R. § 1.401(k)-1(d)(3)(iv)(E).)
Replace the "facts and circumstances" standard for determining necessity with a general standard (26 C.F.R. § 1.401(k)-1(d)(3)(iv)(B)). Under the general standard:
- a hardship distribution may not exceed the amount of the participant's need;
- the participant must have obtained other available distributions under the plan; and
- the participant must represent that he has insufficient cash or other liquid assets to meet the need.

For more information on the safe harbor, see Hardship Distribution Checklist: Safe Harbor (Amount Necessary to Satisfy the Financial Need).

Amounts Includible in Hardship Distributions

The proposed regulations would also incorporate the changes made by the Bipartisan Budget Act of 2018 concerning the types of contributions that may be included in hardship distributions. Specifically, the proposed regulations would permit hardship distributions to be made from:

Contributions to a profit-sharing or stock bonus plan to which Code Section 402(e)(3) applies (26 U.S.C. § 402(e)(3)) and earnings thereon.
Qualified nonelective contributions (QNECs) and earnings thereon.
Qualified matching contributions (QMACs) and earnings thereon.

Relief for Victims of Hurricanes Florence and Michael

The proposed regulations also provide relief to participants affected by Hurricanes Florence and Michael. IRS Announcement 2017-15 provided relief from certain loan and hardship requirements for victims of Hurricane Maria and the California wildfires. The proposed regulations extend the relief provided in Announcement 2017-15 to participants affected by Hurricane Florence or Michael. Relief is provided until March 15, 2019.

Applicability Dates

Generally, the proposed regulations would apply to distributions made in plan years beginning after December 31, 2018, except for:

The prohibition on the six-month suspension of contributions following a hardship distribution would apply to distributions made on or after January 1, 2020. Plan sponsors may choose to apply the prohibition beginning on the first day of the first plan year beginning after December 31, 2018, even if the distribution was made in the prior plan year.
The requirement that plan sponsors obtain the participant's representation regarding insufficient cash or liquid assets to meet a financial need would apply to distributions made on or after January 1, 2020.
The proposed changes to the list of safe harbor expenses would apply to distributions made on or after January 1, 2018.

Request for Public Comments

The agencies invite the public to submit comments on all aspects of the proposed regulations. Comments are due 60 days after the proposed regulations are published in the Federal Register.

Practical Implications

Plan sponsors and practitioners should familiarize themselves with the proposed regulations since amendments and changes to administrative procedures will be required once the proposed regulations are finalized.

IRS Issues Proposed Regulations on Hardship Distribution Rules | Practical Law