In the Bipartisan Budget Act passed in February 2018 (“Act”), Congress loosened certain restrictions on hardship distributions from 401(k) and 403(b) plans.
Currently, when a participant takes a hardship distribution from a 401(k) or 403(b) plan, the participant is prohibited from making any elective deferrals or other employee contributions to the plan and all other plans maintained by the participant’s employer for at least 6 months following the hardship distribution. The Act directs the Department of the Treasury to modify the existing regulations to remove the 6-month prohibition on employee contributions within one year of the enactment of the Act. The revised regulations will apply to plan years beginning after December 31, 2018 and will apply to both 401(k) and 403(b) plans (which are subject to the 401(k) hardship regulations).
The Act also adds a new paragraph to Section 401(k) of the Internal Revenue Code (“Code”), effective for plan years beginning after December 31, 2018. The new paragraph permits hardship distributions to be sourced from not only elective deferrals, but also qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs), as well as earnings on any of these contributions. Additionally, participants will no longer be required to take available loans under a plan before taking a hardship distribution. Although it is likely that these changes were intended to apply to 403(b) plans as well as 401(k) plans, section 403(b) and the existing 403(b) regulations limit hardship distributions to participants’ elective deferrals, so further guidance or a technical correction to the statute will be necessary to apply these expanded hardship sources to 403(b) plans.
Another (perhaps unintentional) change to hardship distributions was made by the Tax Cuts and Jobs Act (“TCJA”). The safe harbor standards for hardship distributions under the 401(k) regulations allow a hardship distribution for the purpose of repairing damage to a principal residence that would qualify for a personal casualty deduction under Code Section 165. The TCJA limits the deductibility of a personal casualty loss under Section 165 of the Code for tax years beginning after December 31, 2017 and before January 1, 2026 only to losses attributable to a federally declared disaster. This means that an isolated casualty loss, such as from a home fire, will not qualify for a hardship distribution under the safe harbor rules. Employers with 401(k) or 403(b) plans that use the safe harbor hardship distribution rules in the 401(k) regulations should comply with these modified requirements until further guidance is issued and substantiate such compliance in accordance with IRS examination standards. (See IRSs-Guidance-for-Substantiation-of-Hardship-Distributions-is-Cold-Comfort-to-Employers)
Note that these changes do not apply to 457(b) or other non-qualified deferred compensation plans, which have separate rules allowing for distributions in the event of an unforeseeable emergency.
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