Changes to Hardship Distribution Rules from Retirement Plans

By Dean Huber

In February of 2018, Congress passed a budget bill intended to keep the government funded and waive the statutory debt limit.  That bill also included some meaningful changes to rules governing hardship withdrawals from retirement plans.

Hardship Distributions under Current Regulations

Under current IRS regulations, a hardship distribution can made from an employee’s elective deferral contributions (typically called an employee’s 401(k) account – the money withheld from the employee’s paycheck), discretionary employer contributions, and regular matching contributions.   Only earnings on these accounts credited on or before December 31, 1988 are available for hardship distribution.  While IRS regulations allow hardship distributions from any of these sources, many plans are more restrictive and only allow them from employee elective deferral contributions.

In addition, a hardship distribution may only be made for:

• An immediate and heavy financial need (events test), and
• Only if other resources are not available to meet that need (needs test)

IRS regulations provide a “safe harbor” for both the events and needs test.  This means that if a plan follows the specific safe harbor requirements, it is deemed to be in compliance with the safe harbor regulations.  If a plan administrator makes a hardship determination outside of the safe harbor guidelines, then it must be prepared to justify that decision under audit.

Events Test

The IRS safe harbor regulations list six specific events that are deemed to satisfy the requirement that the hardship distribution be made to satisfy an immediate and heavy financial need:

1. Deductible medical expenses incurred by the employee, spouse, or dependents.
2. Purchase of the employee’s principal residence.
3. Payment of the next twelve months of post-secondary tuition and certain related costs for the employee, spouse, or dependents.
4. Preventing eviction from the employee’s principal residence or foreclosure of a mortgage on the principal residence.
5. Payment for burial or funeral expenses for the employee’s parent, spouse, child, or dependent.
6. Expenses incurred as the result of certain casualty damage to the employee’s principal residence.

Needs Test

The safe harbor regulations also set forth criteria that, if satisfied, mean the distribution is deemed necessary to satisfy a financial need.  These criteria are:

1. The distribution must not be in excess of the need.
2. All other distributions and loans must have been taken from all other employer plans.
3. Employee elective deferrals must be suspended for at least six months.

Changes made by the 2018 Budget Bill

The newly passed budget bill directs the Treasury Department to make changes to the safe harbor regulations.  It directs them to remove the requirement that an employee take all available nontaxable loans prior to receiving a hardship distribution and to delete the six-month suspension of employee deferrals following the hardship distribution.

The budget bill also makes additional sources of money available for hardship distributions.  Under the new rules, hardship distributions will be allowed from qualified non-elective contributions (QNECs) and qualified matching contributions (QMACs).  In addition, all earnings on all sources of money available for hardship distributions also become eligible for hardship distributions.

These new rules are expected to become effective for plan years beginning after December 31, 2018.  Plan sponsors may want to touch base with their plan document provider to make sure plans and distribution documents are updated to reflect these changes.

At Kernutt Stokes we have a group of employees specializing in employee plans and their compliance with various Treasury and Department of Labor regulations.  If you have any concerns about your plans and their compliance with various rules and regulations, feel free to call Dean Huber or Andrea Smith at 541.687.1170.